Investment
Banking
Prep-book
Contents
1. What is an investment bank
1
2. Differences between an IB and other entities
2
3. Buy Side vs Sell Side
3
4. Types of Investment Banks
3
5. Organisation and divisions of an IB
4
6. Primary vs Secondary market
6
7. What is an IPO?
8
8. IB responsibilities in an IPO
10
9. Valuation
12
a. DCF
14
b. Comparable company analysis
18
c. Comparable transaction analysis
20
d. Football field
21
10. Mergers & Acquisitions
23
11. Alternatives to M&A
27
12. M&A Process
29
13. Types of synergies
31
14. Important documents in an M&A transaction
33
15. Role of an IB in an M&A transaction
36
16. Transaction characteristics
36
17. Hostile takeovers
37
18. Preparation tips
40
What is an
Investment
Bank?
Investment Banks are financial intermediaries that help
large companies, government and institutions manage
their money by performing following functions:
Raising Capital from Markets (IPO, Bonds)
Underwriting Debt or Equity Securities
Mergers & Acquisitions
Restructuring of Firms
Financial Advisory
Risk Management
Some prominent investment banks are J.P. Morgan,
Goldman Sachs, Morgan Stanley, and Citigroup.
1
How does an Investment Bank
differ from:
Commercial Bank: Investment Banks help large entities make sound
investments, issue stock and make mergers and acquisitions while
commercial banks accept deposits at a lower rate of interest and disburse
loans at higher rates thereby earning profits. Commercial banks provide
their services to the general public and businesses for their day-to-day
banking and credit needs while IBs provide their services to large
institutions, corporations and governments. Investment Banks assume
high risk and are less regulated while commercial banks assume low risk
and are highly regulated.
Merchant Bank: Investment Banks are the middleman between the issuer
of securities and investors, also providing various financial services to the
clients while the key area of merchant banks is international finance and
so their key work is related to foreign corporate finance, foreign trade
finance and real estate investment. Another key difference is that
merchant banks mainly deal with HNIs and medium sized corporations
while investment banks deal with huge corporations having higher
financial muscle power.
Corporate Finance: While IBs coordinate and execute M&As, offer
advisory services and help raise funds, Corporate Finance is a division or
department in a company whose objective is to maximize the shareholders
wealth. It handles all the financial activities of a firm from deciding the
capital structure, raising funds, putting them to use and finally
distributing profits as dividends. Investment banking is a part of corporate
finance. A company can have corporate finance without investment
banking but it can't have investment banking without corporate finance.
Universal Bank: Universal Bank combines the services of a commercial
bank and investment bank providing all services from within one entity.
The services range from those of commercial banks such as accepting
deposits and providing loans to those of investment banks such as M&A
and underwriting. Even though a universal bank offers a multitude of
services, it may still choose to specialize in a subset of banking services.
How Commercial Banks differ from NBFCs: NBFCs do not have banking
license and cannot accept demand deposits. NBFCs are incorporated
under the Companies Act, 2013; Commercial Banks under Banking
Regulation Act, 1949. Banks are directly or indirectly involved in the
payment and settlement cycle while NBFCs are not. Banks do not have the
right to operate any other business than banking in contrast to NBFCs.
2
Buy side v/s Sell side
The functions of an investment bank can also be divided into one of two
prime categories: buying or selling.
Buy Side: Investment Banks take up the role of offering suggestions to
large institutional investors such as mutual funds, pension funds, hedge
funds, etc. who are interested in buying financial instruments to meet
their return targets. Buy side performs various other activities like
managing their clients’ money, making investment decisions and
performing in-house research on investment opportunities.
Working on the buy side in a M&A simply means that the client is the
buyer. Buy side finds opportunities for them to acquire other businesses.
Sell Side: Sell Side deals with the role of the creation, promotion and
selling of traded securities. It helps the businesses and governments raise
the money they need by finding the investors for the securities being
offered. They prepare an analysis, with the help of extensive financial
modeling to determine what they believe the company is worth. Next,
they prepare a variety of marketing materials to be distributed to potential
investors.
In a M&A, sell side means working with the clients to help find
counterparty for the sale of their business.
Types of Investment Banks
Bulge Bracket: Bulge bracket investment banks are the world’s largest and
most profitable multi-national full-service investment banks. They cover
most or all investment banking services including trading, financing, asset
management and M&A services. They handle the largest deals and have
the largest clients. They operate internationally and have a large global
and domestic presence. JPMorgan Chase, Goldman Sachs, Morgan Stanley,
Citigroup, UBS, Barclays, Credit Suisse, Deutsche Bank, Bank of America
Merrill Lynch are some of the bulge bracket banks.
Boutique Banks: Boutique banks differ from bulge bracket banks in terms
of their size and services offered. They do not provide full-service
investment banking but choose to focus on one or select few areas of the
business. Boutique Banks can be further divided into:
3
Types of Investment Banks
i. Elite Boutiques: An elite boutique investment bank is a non-fullservice bank that focuses on pure investment banking activities of M&A
advisory and restructuring rather than capital markets. They advise on the
same types and sizes of deals as the bulge bracket banks but often with an
industry or geographic specialty. Most elite boutiques begin as regional
banks and gradually work up to elite status through handling successions
of larger and larger deals for more prestigious clients. They are also
referred to as ‘independent investment banks.’ Lazard LLC, Evercore
Group LLC and Moelis & Company are some of the well-known elite
boutique investment banks.
ii. Regional Banks: Regional banks typically focus on a particular country
or a part of the country. These firms have multiple offices with national
presence. While the bulge bracket banks try to continuously grow and
improve their market share, there is plenty of room for regional players
too. Few examples include SBI Capital Markets in India, Macquarie Group
in Australia and China International Capital Corporation in China.
Middle Market Banks: In terms of services, middle market banks are
comparable to bulge bracket banks. They provide services in all
investment bank products (M&A, ECM, DCM) and coverage groups
(sector-wise). However, some banks specialize in certain groups. As their
name implies, they are in the “middle” of these banks. They are more
specialized than bulge bracket banks, but not as much as boutique banks.
Due to the numerous types of boutiques that exist, boutiques can work
with companies with smaller or larger deal sizes than middle markets in
terms of deal size while deal sizes in Bulge bracket banks are always higher
than these banks.
How Investment Banks are Organized:
Nearly all major investment banks divide their operations in three key
areas, including the front office, middle office and back office.
The Front Office: Front Office is the part of the Investment Bank that
courts companies looking to do deals, directly dealing with clients. From
the front office, they help usher the M&A process by pairing up buyers
and sellers. The front office also conducts trading using the firm’s money
which is called proprietary trading.
4
How Investment Banks are Organized:
The Middle Office: The Middle office is often called the ‘voice of reason’
as it directly supports the front office in areas of compliance, information
technology, law and risk management. It sees to it that the deals negotiated
by the front office conform to the agreements and also tracks profits and
losses.
The Back Office: The Back office is involved in settlements, clearances,
records maintenance, accounting and human resources and technology. It
is the ‘engine room of an investment bank’ as it ensures all the functions
happen smoothly: payments get processed in settlements, personnel get
their salaries on time, systems are working fine, etc.
Divisions of an Investment Bank
Some of the divisions of an investment bank include:
M&A: Services include providing advisory on M&A transactions, building
a detailed valuation and providing expertise in structuring the deal.
Debt Capital Markets: It provides expertise to companies on raising or
structuring of debt to financing acquisitions.
Equity Capital Market: This division provides advice on equity and equity
derived products like shares, options, futures, etc.
Restructuring: Restructuring division improves the overall structure of
the company making it more profitable in the long run.
Sales, trading and research division: It works with clients, provides
research outlook/views on companies, markets and products and executes
trade in the open market for the investors.
With an investment banking division, bankers are typically bucketed into
two groups: product and industry. Bankers in product group have product
knowledge about M&As, equity markets, debt markets, etc. and tend to
execute transactions related to their product in a variety of different
industries. There are also sub-groups within product groups. For example,
the securities underwriting group includes syndicate finance, high yield
bonds, private placements, etc. Bankers in industry group cover specific
industries (such as media & telecom, consumer & retail) and tend to do
more pitching activity.
5
Primary Market vs Secondary Market
Primary Market
The primary market creates new securities and offers them to the public.
In primary market, the transaction is directly conducted between the
issuer and the buyer. It is also known as the new issues market.
Money can be raised in the primary market by any of the following four
ways:
1. Public Issue: Public issue, also known as IPO (Initial Public Offering),
means selling securities to the public at large. It is the most vital method
to sell financial securities. A follow-on Public Offer (FPO) is an issuance of
additional shares made by a company after an IPO.
2. Rights Issue: Whenever a company needs to raise supplementary
equity capital, the shares must be first offered to present shareholders on
a pro-rata basis, which is known as the Rights Issue.
3. Private Placement: In private placement, the offer and sale of
securities is made between the issuer and a select group of investors such
as venture capital funds, mutual funds, insurance companies and banks.
4. Preferential Allotment: In preferential allotment, bulk issue of fresh
shares is done to people who want to acquire a strategic stake and whom
the company considers to be value addition as shareholders.
6
Primary Market vs Secondary Market
Secondary Market
The securities already issued in the primary market are bought and sold in
the secondary market without any involvement of the company which
issued them in the first place. Securities are directly traded by the buyers
and sellers with the transactions being facilitated by stock exchanges and
brokers.
Secondary Market is divided into:
A. Stock Exchange
i. Auction Market: In the auction market, the price put forward by
buyers called bid price and sellers called ask price are decided by market
participants. Buyers and sellers enter auctions and the execution of a trade
happens if the market participant’s bid and offer prices match. There is a
singular entity in the auction market that controls the trading activity and
there is a centralized trading floor. NYSE is an auction market.
ii. Electronic Exchange: Auction exchanges across the world have been
replaced by electronic exchanges. With an electronic exchange, there has
been higher liquidity and better matching of trades. NASDAQ is an
electronic exchange.
B. Dealer (OTC) Market: Dealer Market is a financial market consisting
of multiple dealers buying and selling securities using their own account.
Here, dealers act as market makers and set bid and offer prices. The
exchange of securities is executed through the dealers and there is no
centralized trading floor. NASDAQ is an example of a dealer market.
C. Electronic Communication Networks (ECNs): Electronic
Communication Networks (ECNs) allow the investors to bypass the market
makers (brokers and dealers) and trade for themselves on an exchange.
ECNs are usually used by institutional investors and offer reduced
transaction cost. An example of ECN is Interbank Network Electronic
Transfer (INET).
National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) are the
two largest and most popular stock exchanges of India located in Mumbai.
Sensex (Stock Exchange Sensitivity Index) is the benchmark equity index
of BSE covering 30 of the largest and most actively-traded stocks on the
BSE. Base year of Sensex is 1978-79 and base value is 100. Nifty (NSE 50) is
the benchmark index of the 50 most prominent stocks listed on NSE. Base
year of Nifty is 1995 and base value is 1000
7
What is an IPO?
Initial public offering is the process by which a private company can go
public by sale of its stocks to the general public. It could be a new, young
company or an old company which decides to be listed on an exchange
and hence goes public.
In an IPO, it may happen that promoters, venture capitalists, PE firms or
HNIs who invested earlier in the company sell their shares to the public
which is called Offer for Sale (OFS). Here, the money raised is not
received by the company but by the existing investors who are offloading
their stake.
A company planning an IPO will typically select an underwriter or
underwriters. It will also choose an exchange in which the shares will be
issued and subsequently traded publicly.
Pros of an IPO:
The company gets access to investment from the entire investing
public to raise capital.
Increased transparency that comes with required quarterly reporting
can usually help a company receive more favourable credit borrowing
terms than as a private company.
A public company can raise additional funds through FPO in future if it
has gone for an IPO.
Public companies can attract and retain better management and skilled
employees through liquid stock equity participation (e.g., ESOPs).
IPOs can give a company a lower cost of capital for both equity and debt.
Employee Stock Option Plan (ESOP) is an employee benefit scheme under
which the company encourages its employees to acquire ownership in the
form of shares. These shares are allotted to the employees at a rate
considerably lesser than the prevailing market rate. Apart from the
employee-benefit motive, ESOPs are also meant to align the interests of
the employees with that of the shareholders, to ensure they focus better
on company performance and growth so that the value of their shares
appreciates. Typically, employee stock options are issued by the company
and cannot be sold, unlike listed or exchange-traded options
8
Cons of an IPO:
An IPO is expensive and the costs of maintaining a public company are
ongoing and usually unrelated to the other costs of doing business.
Significant legal, accounting and marketing costs arise, many of which
are ongoing.
The company becomes required to disclose financial, accounting, tax,
and other business information. During these disclosures, it may have
to publicly reveal secrets and business methods that could help
competitors.
There is always a risk that required funding will not be raised if the
market does not accept the IPO price.
Why so many IPOs in recent times?
More than 50 companies have made their debut on stock exchanges in the
past one year. Following are some of the reasons behind the IPO rush:
Excellent performance of stock markets
Higher participation of first-time and retail investors (Over 14.2 million
new individual investors participated in the market in 2020-21 as per a
SBI report)
Ample liquidity in the financial markets
Companies raising capital either in the wake of losses or to fund
business expansion
Faster than expected economic recovery
The Question an IB helps a company answer
Is IPO a right thing to do or should we pick a different way to raise
capital?
What is the comfort for listing the company? (a Chinese company may
prefer to get listed in Hong Kong rather than in New York)
Does the company comply with all the regulations necessary for the
offering? (This might include publishing audited financial statements
or segmental reporting)
Are the markets ready for this? (You don’t want to conduct an IPO in an
adverse environment or when your company will not be understood
for its true worth)
What is the general public perception about the industry as well as the
company?
9
Responsibilities of Investment Bank in an IPO
Underwriting
Underwriting is the process by which an individual or institution assumes
the financial risk of another party in exchange of a fee. In an IPO,
investment banks act as intermediaries between the company and
investors and sign an underwriting agreement with the company
containing details about the deal, amount to be raised and details of
securities being issued.
They are three types of underwriting agreements:
i) Firm Commitment Underwriting: In a firm commitment underwriting,
the underwriter guarantees to purchase all the securities offered for sale
by the issuer regardless of whether they can sell them to investors.
ii) In a best-efforts underwriting agreement, underwriters do their best to
sell all the securities offered by the issuer, but the underwriter isn't
obligated to purchase the securities for its own account.
iii) All or Nothing Underwriting: Investors’ funds are held in escrow until
all of the securities are sold. If all of the securities are sold, the proceeds
are released to the issuer. If all of the securities are not sold, the issue is
canceled and the investors’ funds are returned to them.
Registration of IPO and preparation of DRHP
Investment Banks help in the preparation of Draft Red Herring Prospectus
(DRHP) which comprises of all the compulsory disclosures to be made as
per the SEBI and Companies Act. It includes every important detail like
industry description, business description, management, financial
information, key risk factors, use of proceeds and other necessary
information required by the regulators.
Create a Buzz by Roadshows
Investment Banks endeavour to create a buzz about the company in the
market by roadshows. Key highlights of the company are shared with
various people including business analysts and fund managers via
Question-and-Answer sessions, group meetings, multimedia presentations,
etc. to attract potential investors.
10
Responsibilities of Investment Bank in an IPO
Pricing of an IPO
One of the most important steps in the IPO process is its pricing. IBs
initiate pricing of an IPO either through Fixed Price IPO or by Book
Binding Offer. In Fixed Price Offering, price of the stock is announced in
advance. In Book building process, price ranges are announced within
which the investors can quote their bids. Cut-off price is determined at the
end of the bidding process which is the final price of the issue. IB also
decides what should be the size of the issue and how it should be allocated
between among Qualified Institutional Investors (QIBs), Non-Institutional
Investors (NIIs) and Retail Investors.
Stabilization
After the issue is brought to the market, underwriter has to create a market
for the stock and ensure after-market stabilization when there is
increasing or decreasing demand for it. This is ensured by greenshoe
option which allows the IB to buy up to 15% of additional shares if prices
fall without the risk of buying them if prices rise.
Recent IPOs
11
Valuation
Valuation methodologies
Valuation is often not a helpful tool in determining when to sell hyper-growth
stocks”, Henry Blodget, Merrill Lynch Equity Research Analyst in January 2000,
in a report on Internet Capital Group. There have always been investors in
financial markets who have argued that market prices are determined by the
perceptions (and misperceptions) of buyers and sellers, and not by anything as
prosaic as cash flows or earnings. Perceptions matter, but they cannot be all the
matter.
There are many different ways to value a company. Each of these have their own
advantages and disadvantages.
Discounted cashflow valuation, relates the value of an asset to the present
value of expected future cash flows on that asset.
Relative valuation, estimates the value of an asset by looking at the pricing of
'comparable' assets relative to a common variable like earnings, cashflows,
book value or sales.
Contingent claim valuation, uses option pricing models to measure the value
of assets that share option characteristics.
Before we jump into the different valuation methods, it is important to
understand the difference between book value and market value.
Book Value
The book value of a stock is theoretically the amount of money that would be
paid to shareholders if the company was liquidated and paid off all of its
liabilities. As a result, the book value equals the difference between a company's
total assets and total liabilities. Book value is also recorded as shareholders' equity.
In other words, the book value is literally the value of the company according to
its books (balance sheet) once all liabilities are subtracted from assets.
Intrinsic value
Intrinsic value is a measure of what an asset is worth. This measure is arrived at
by means of an objective calculation or complex financial model, rather than
using the currently trading market price of that asset. In financial analysis this
term is used in conjunction with the work of identifying, as nearly as possible, the
underlying value of a company and its cash flow. In options pricing it refers to the
difference between the strike price of the option and the current price of the
underlying asset.
12
Valuation
Market Value
The market value is the value of a company according to the financial markets.
The market value of a company is calculated by multiplying the current stock
price by the number of outstanding shares that are trading in the market. Market
value is also known as market capitalization.
For example, as of the end of 2017, Bank of America had over 10 billion shares
outstanding (10,207,302,000) while the stock traded at $29.52, making Bank of
America's market value or market capitalization $301 billion (10,207,302,000 *
29.52).
The purpose of the document is to introduce the participants to develop a basic
understanding of the following methods:
• Discounted Cash Flow – Free cash flow to firm method of valuation. Every asset
has an intrinsic value that can be estimated, based upon its characteristics in terms
of cash flows, growth and risk.
To use discounted cash flow valuation, you need the following information:
• To estimate the life of the asset
• To estimate the cash flows during the life of the asset
• To estimate the discount rate to apply to these cash flows to get present value
Top-down approach
Top-down forecasting is a method of estimating a company’s future performance
by starting with high-level market data and working “down” to revenue. This
approach starts with the big picture and then narrows in on a specific company.
This guide will provide examples of how it works and explain why it’s commonly
used in financial modeling and valuation.
Bottom-Up approach
Bottom-up forecasting is a method of estimating a company’s future
performance by starting with low-level company data and working “up” to
revenue. This approach starts with detailed customer or product information and
then broadens up to revenue. This guide will provide examples of how it works
and explain why it’s commonly used in financial modeling and valuation.
13
Valuation
Steps in DCF method of valuation:
Free cash flows
Free cash flow (FCF) represents the cash a company generates after accounting
for cash outflows to support operations and maintain its capital assets. Unlike
earnings or net income, free cash flow is a measure of profitability that excludes
the non-cash expenses of the income statement and includes spending on
equipment and assets as well as changes in working capital from the balance
sheet.
Interest payments are excluded from the generally accepted definition of free
cash flow. Investment bankers and analysts who need to evaluate a company’s
expected performance with different capital structures will use variations of free
cash flow like free cash flow for the firm and free cash flow to equity, which are
adjusted for interest payments and borrowings. Similar to sales and earnings, free
cash flow is often evaluated on a per share basis to evaluate the effect of dilution.
FCFF vs FCFE
The two types of free cash flow measures used in valuation are Free cash flow to
the firm (FCFF) and Free cash flow to equity (FCFE). Usually, when we talk about
free cash flow we are referring to FCFF. FCFF is usually computed by adjusting
operating EBIT for non-cash expenses and fixed and working capital investments.
FCFF= Operating EBIT- Taxes + Depreciation/Amortization (non-cash expenses)fixed capital expenditure-Increase in net working capital
We then we do a DCF using FCFF, we arrive at enterprise value by discounting
the cash flows with the weighted average cost of capital (WACC). Here the costs of
all the sources of capital are captured in the discount rate since FCFF takes into
consideration the entire capital structure of the company. Since this cash flow
includes the impact of leverage, it is also referred to as levered cash flow. Thus, if
the firm has common equity as the only source of capital, its FCFF and FCFE are
equal. FCFE is usually computed by adjusting post-tax operating EBIT for a noncash expense, interest expense, capital investments, and net debt repayments.
FCFE=Operating EBIT- Interest- Taxes + Depreciation/Amortization (non-cash
cost)– fixed capital expenditure-Increase in networking capital-net debt
repayment
Where net debt repayment= principal debt repayment –new debt issue
14
Valuation
To summarize, there are two ways to calculate the free cash flows to the
firm
Method 1:
Method 2:
Earnings before Interest and Tax (EBIT)
- Tax Rate X EBIT
= Net Operating Profit after Tax (NOPAT)
- Change in net working capital
- Capital expenditure
=+ Depreciation and amortization (D&A)
= Free cash flows to the firm
Net Income
+ Interest X (1-Tax rate)
- Change in net working capital
- Capital expenditure
+ Depreciation and amortization (D&A)
= Free cash flows to the firm
The Weighted Average Cost of Capital is calculated according to the
following formula:
WACC = (Kd x (1-t) x D/V) + (Ke x E/V)
Where:
• Kd = cost of debt
• t = marginal tax rate
• D/V = debt to value (capital) ratio (D and V based on market values)
• Ke = cost of equity
• E/V = equity to value (capital) ratio (E and V based on market values)
Cost of debt is generally the yield on new debt issued by the company.
Alternatively, it can also be calculated by finding out the credit rating of
the firm and then the rate applicable as per that credit rating. Because the
interest that accrues on debt can be tax deductible, the actual cost of the
borrowing is less than the stated rate of interest. To deduct interest on
debt financing as an ordinary business expense, the underlying loan
money must be used for business purposes. In addition, you must be
legally liable for repaying the debt, a legitimate creditor-debtor
relationship must exist between you, or the business, and the lender. The
creditor must have a true expectation of being repaid.
• Cost of equity can be calculated through the Capital Asset Pricing Model
(CAPM) model.
• Ke = Rf + B(Rm-Rf)
15
Valuation
Where:
• Rf = risk free rate (generally the yield on government treasury bonds
since they are considered the safest bonds and the maturity of the
government bond should be matched with the expected time horizon of
the project.
• B = beta (volatility of the company stock price to the price of the
benchmark index) Since the broad market has a beta coefficient of 1, a
portfolio beta of less than 1 means that the portfolio has lower systematic
risk than the market and vice versa.
• Rm = return on the market portfolio generally taken as return on broad
market indices like S&P or NIFTY.
• Growth rate can be the growth rate of the industry in which the company
operates in or the industry growth rate. A conservative measure should
generally be taken for the same.
Systematic risk
Systematic risk refers to the risk inherent to the entire market or market
segment. Systematic risk, also known as “undiversifiable risk,” “volatility”
or “market risk,” affects the overall market, not just a particular stock or
industry.
Unsystematic risk
Unsystematic risk is the risk that is unique to a specific company or
industry. In the context of an investment portfolio, unsystematic risk can
be reduced through diversification
Pros and cons of debt financing
Pros
Retain control: When you agree to debt financing from a lending
institution, the lender has no say in how you manage your company. You
make all the decisions. The business relationship ends once you have
repaid the loan in full.
Tax advantage: The amount you pay in interest is tax deductible,
effectively reducing your net obligation.
Easier planning: You know well in advance exactly how much principal
and interest you will pay back each month. This makes it easier to budget
and make financial plans.
16
Valuation
Cons
Qualification requirements: You need a good enough credit rating to
receive financing.
Discipline: You’ll need to have the financial discipline to make
repayments on time. Exercise restraint and use good financial judgment
when you use debt. A business that is overly dependent on debt could be
seen as ‘high risk’ by potential investors, and that could limit access to
equity financing at some point.
Collateral: By agreeing to provide collateral to the lender, you could put
some business assets at potential risk. You might also be asked to
personally guarantee the loan, potentially putting your own assets at risk.
Pros and cons of equity financing
Pros
Less burden: With equity financing, there is no loan to repay. The
business doesn’t have to make a monthly loan payment which can be
particularly important if the business doesn’t initially generate a profit.
This in turn, gives you the freedom to channel more money into your
growing business.
Credit issues gone: If you lack creditworthiness – through a poor credit
history or lack of a financial track record – equity can be preferable or
more suitable than debt financing.
Learn and gain from partners: With equity financing, you might form
informal partnerships with more knowledgeable or experienced
individuals. Some might be well-connected, allowing your business to
potentially benefit from their knowledge and their business network.
Cons
Share profit: Your investors will expect – and deserve – a piece of your
profits.
Loss of control: The price to pay for equity financing and all of its
potential advantages is that you need to share control of the company.
Potential conflict: Sharing ownership and having to work with others
could lead to some tension and even conflict if there are differences in
vision, management style and ways of running the business. It can be an
issue to consider carefully.
17
Valuation
Terminal Value is a lump sum of cash flow at the end of a stream of cash
flows. This lump sum represents either the proceeds from exiting the
investment or present value (at the future date) of all cash flows beyond
the forecast horizon.
Terminal value for the year = FCFF (of terminal year) x (1+g) / (WACC-g)
Where:
g = Growth rate
WACC = Weighted average cost of capital
Enterprise Value (Value of Operations) is given by the following formula:
Where:
CF = Free cash flows to firm
r = Weighted average cost of capital
CFn = Terminal value
Comparable Company Analysis - The crux of this method is captured in
the following figure.
18
Valuation
Let us understand this better with the help of an example. Suppose an
analyst has gathered the following information on the target company –
XYZ Co.
If the typical takeover premium is 20%, what is XYZ Company’s value?
Assuming that the average of the values given from different multiples is
appropriate method to calculate the value:
Estimated takeover price = 237.5 Million X 1.2 (Including takeover
premium of 20%)
= 285 Million
Advantages
• Provides reasonable estimate of the target company’s value
• Readily available inputs
• Estimates based on market’s value of company attributes
Disadvantages
• Sensitive to market mispricing
• Sensitive to estimate of the takeover premium, and historical premiums
may not be accurate to apply to subsequent mergers
• Does not consider specific changes that may be made in the target postmerger
19
Valuation
Let us understand this better with the help of an example. Suppose an
analyst has gathered the following information on the target company –
XYZ Co.
Comparable Transaction Analysis
The essence of this method is contained in the following figure
Illustrating this with the help of an example, suppose an analyst has
gathered the following information on the target company – XYZ Co.
Estimate the value of the company using the comparable transaction
analysis, giving the cash flow multiple 70% weight and 10% to all the other
metrics.
Assuming that the average of the values given from different multiples is
appropriate method to calculate the value:
Value of the Company = (0.7 * 240) + (0.1 * 150) + (0.1 * 250) + (0.1 * 300)
Value = 238 Million
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Valuation
Comparable Transaction Analysis
Advantages
• Does not require specific estimation of a takeover premium
• Based on recent market transactions,so information is current and
observed
• Reduces litigation risk
Disadvantages
• Depends on takeover transactions being correct valuations
• There may not be sufficient transactions to observe the valuations
• Does not include the value of changes to be made in target
Football field
A football field is a triangulation graph where values obtained through
different methods are represented graphically. It gives the details of the
range of company valuation based on different methods,to arrive at a final
range.
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Valuation
Contingent Claim Valuation
Options have several features as follows:
• They derive their value from an underlying asset, which has value
• The payoff on a call (put) option occurs only if the value of the
underlying asset is greater (lesser) than an exercise price that is specified
at the time the option is created. If this contingency does not occur, the
option is worthless.
• They have a fixed life.
Any security that shares these features can be valued as an option.
Direct Examples of Options
Listed options, which are options on traded assets, that are issued by,
listed on and traded on an option exchange.
Warrants, which are call options on traded stocks, that are issued by the
company. The proceeds from the warrant issue go to the company, and
the warrants are often traded on the market.
Contingent Value Rights, which are put options on traded stocks, that
are also issued by the firm. The proceeds from the CVR issue also go to
the company
Scores and LEAPs, are long term call options on traded stocks, which
are traded on the exchanges.
Indirect Examples of Options
Equity in a deeply troubled firm - a firm with negative earnings and
high leverage - can be viewed as an option to liquidate that is held by
the stockholders of the firm. Viewed as such, it is a call option on the
assets of the firm.
The reserves owned by natural resource firms can be viewed as call
options on the underlying resource, since the firm can decide whether
and how much of the resource to extract from the reserve.
The patent owned by a firm or an exclusive license issued to a firm can
be viewed as an option on the underlying product (project). The firm
owns this option for the duration of the patent.
The rights possessed by a firm to expand an existing investment into
new markets or new products.
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Valuation
Advantages of Using Option Pricing models
Option pricing models allow us to value assets that we otherwise would
not be able to value. For instance, equity in deeply troubled firms and
the stock of a small, bio-technology firm (with no revenues and profits)
are difficult to value using discounted cash flow approaches or with
multiples. They can be valued using option pricing.
Option pricing models provide us fresh insights into the drivers of
value. In cases where an asset is deriving its value from its option
characteristics, for instance, more risk or variability can increase value
rather than decrease it.
Disadvantages of using option pricing models
When real options (which includes the natural resource options and the
product patents) are valued, many of the inputs for the option pricing
model are difficult to obtain. For instance, projects do not trade and
thus getting a current value for a project or a variance may be a
daunting task.
The option pricing models derive their value from an underlying asset.
Thus, to do option pricing, you first need to value the assets. It is
therefore an approach that is an addendum to another valuation
approach.
Finally, there is the danger of double counting assets. Thus, an analyst
who uses a higher growth rate in discounted cash flow valuation for a
pharmaceutical firm because it has valuable patents would be double
counting the patents if he values the patents as options and adds them
on to his discounted cash flow value.
Mergers and Acquisitions
A Merger between two Title / Heading companies entails their combining
into a single entity. The combined entity could either be the one company
out of the two merging entities that survives and lends its name to the
combined entity (Merger by Absorption), or a new entity altogether
(Merger by Consolidation).
An Acquisition or Takeover implies the purchase by one entity of a
controlling stake (>50%) in another company; or a certain
division/segment in the company. In a merger, the new entity essentially
has 100% (Note: >50%) of the combining entities. Mergers & Acquisitions
are therefore intertwined in meaning.
23
Mergers and Acquisitions
Horizontal and vertical mergers are two common ways that one business
firm can buy or otherwise acquire another. Horizontal mergers concern
two businesses that compete with each other. Vertical mergers concern
two businesses that operate within the same supply chain. Other types of
common mergers include congeneric merger and reverse merger.
Horizontal merger
Horizontal mergers are a type of non-financial merger. In other words, a
horizontal merger is undertaken for reasons that have little to do with
money, at least not directly. Instead, a business would conduct a
horizontal merger to reduce its competition in the marketplace.
Examples of horizontal mergers are abundant in the banking industry.
Deregulation during the '80s and '90s expanded what a single bank could
do (for example, investment banks were granted the ability to offer
commercial banking services) and allowed bank holding companies to
conduct interstate bank mergers (as opposed to restricting the number of
states in which a bank could operate).
As a result, many banks consolidated into single companies. For example,
in 2000, J.P. Morgan and Chase Manhattan Bank merged into a single
company—instantly creating the sixth-largest banking institution.
Vertical merger
A vertical merger or vertical integration is a merger between two
companies that produce different products or services along the supply
chain toward the production of some final product. Vertical mergers are
usually conducted to increase efficiency along the supply chain which, in
turn, increases profits for the acquiring company.
Unlike horizontal mergers, vertical mergers never involve one business
directly acquiring its competition. However, just like horizontal mergers,
vertical mergers can result in antitrust problems in the marketplace. Even
though the acquisition in and of itself doesn't reduce competition, the
impact of one company acquiring a greater share of the supply chain
could effectively reduce competition.
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Mergers and Acquisitions
For example, consider the automobile industry. If a car manufacturer were
to buy up other businesses that exist along its supply chain, they might not
directly reduce the ability of other car manufacturers to compete, but they
would gain some control over those manufacturers. If the car
manufacturer bought up seat belt manufacturers, it could effectively
control the price that all car manufacturers pay for seat belts. It would
profit off every car made with the seat belts, whether or not the car was
manufactured by that company or not. The more aspects of the supply
chain a single company owns, the more it reduces competition in that
industry.
Congeneric merger
A congeneric merger is a type of merger where two companies are in the
same or related industries or markets but do not offer the same products.
In a congeneric merger, the companies may share similar distribution
channels, providing synergies for the merger. The acquiring company and
the target company may have overlapping technology or production
systems, making for easy integration of the two entities. The acquirer may
see the target as an opportunity to expand their product line or gain new
market share. The overlap between the two companies in a congeneric
merger can create a synergy where the combined performance of the
merged companies is greater than the individual companies themselves.
Reverse merger
Reverse mergers are also commonly referred to as reverse takeovers or
reverse initial public offerings (IPOs). A reverse merger is a way for
private companies to go public by acquiring the public company. It is an
attractive strategic option for managers of private companies to gain
public company status.It is a less time-consuming and less costly
alternative to the conventional initial public offerings (IPOs). Public
company management enjoys greater flexibility in terms of financing
alternatives, and the company's investors enjoy greater liquidity. Public
companies face additional compliance burdens and must ensure that
sufficient time and energy continues to be devoted to running and
growing the business. A successful reverse merger can increase the value
of a company's stock and its liquidity.
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Mergers and Acquisitions
Furthermore, there are a couple of other types of mergers, although
uncommon, namely Conglomerate merger and Roll-Up merger. They are
described in detail below:
Conglomerate merger
A conglomerate merger is a merger between firms that are involved in
totally unrelated business activities. These mergers typically occur
between firms within different industries or firms located in different
geographical locations.
There are two types of conglomerate mergers: pure and mixed. Pure
conglomerate mergers involve firms with nothing in common, while
mixed conglomerate mergers involve firms that are looking for product
extensions or market extensions.Two firms would enter into a
conglomerate merger to increase their market share, diversify their
businesses, cross-sell their products, and to take advantage of synergies.
Roll-Up merger
A roll-up merger is when an investor, such as a private equity firm, buys
up companies in the same market and merges them together. Roll-up
mergers, also known as a "roll up" or a "rollup," combine multiple small
companies into a larger entity that is better positioned to enjoy economies
of scale. Private equity firms use roll-up mergers to rationalize
competition in crowded and/or fragmented markets and to combine
companies with complementary capabilities into a full-service business,
for instance, an oil exploration company can be combined with a drilling
company and a refiner.
Leveraged buyout
A leveraged buyout (LBO) is the acquisition of another company using a
significant amount of borrowed money to meet the cost of acquisition.
The assets of the company being acquired are often used as collateral for
the loans, along with the assets of the acquiring company.
One of the largest LBOs on record was the acquisition of Hospital
Corporation of America (HCA) by Kohlberg Kravis Roberts & Co. (KKR),
Bain & Co., and Merrill Lynch in 2006. In a leveraged buyout (LBO), there
is usually a ratio of 90% debt to 10% equity.
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Mergers and Acquisitions
Management buyout
A management buyout (MBO) is a transaction where a company’s
management team purchases the assets and operations of the business
they manage. A management buyout is appealing to professional managers
because of the greater potential rewards and control from being owners of
the business rather than employees. The main reason for a management
buyout (MBO) is so that a company can go private in an effort to
streamline operations and improve profitability. In a management buyout
(MBO), a management team pools resources to acquire all or part of a
business they manage. Funding usually comes from a mix of personal
resources, private equity financiers, and seller-financing. A management
buyout (MBO) stands in contrast to a management buy-in, where an
external management team acquires a company and replaces the existing
management.
Management buy-in
A management buy-in (MBI) is a corporate action in which an outside
manager or management team purchases a controlling ownership stake in
an outside company and replaces its existing management team. This type
of action can occur when a company appears to be undervalued, poorly
managed, or requires succession.
Alternatives to M&As
Joint Venture Strategic Alliance
A joint venture is a strategic alliance where two or more parties, usually
businesses, form a partnership to share markets, intellectual property,
assets, knowledge, and, of course, profits. A joint venture differs from a
merger in the sense that there is no transfer of ownership in the deal.
This partnership can happen between goliaths in an industry. Cingular, for
instance, is a strategic alliance between SBS and Bellsouth. It can also
occur between two small businesses that believe partnering will help them
successfully fight their bigger competitors.
Companies with identical products and services can also join forces to
penetrate markets they wouldn't or couldn't consider without investing
tremendous resources. Furthermore, due to local regulations, some
markets can only be penetrated via joint venturing with a local business.
In some cases, a large company can decide to form a joint venture with a
smaller business in order to quickly acquire critical intellectual property,
technology, or resources otherwise hard to obtain, even with plenty of
cash at their disposal.
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Mergers and Acquisitions
Equity Strategic Alliance
An equity strategic alliance is created when one company purchases a
certain equity percentage of the other company. If Company A purchases
40% of the equity in Company B, an equity strategic alliance would be
formed.
Non Equity Strategic Alliance
A non-equity strategic alliance is created when two or more companies
sign a contractual relationship to pool their resources and capabilities
together.
Advantages of Strategic Alliance
The synergy resulting from alliances can produce an effective way of
manufacturing and increase operating profitability
Alliance can save a lot of funds which could incur due to research of a
product or other manufacturing-related research.
Sharing resources can lead to the optimization of resources, thus
leaving less or none resources idle.
To enter a new market where brand awareness is less, the alliance will
come in handy and has its importance.
Disadvantages of Strategic Alliance
Due to powerful partners in an alliance, another company may lose its
operational control of the business.
Inefficient planning of alliance can incur more loss than the actual loss
without alliance and thus affect the profitability.
It is challenging to keep the objectives of the alliance updated over a
period of time.
There will be management discrepancy due to executives from both the
partnering firms.
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Mergers and Acquisitions
Benefits of Mergers and Acquisitions
1. For greater market share and access to new customers. Eg. Kotak
Mahindra Bank’s acquisition of ING Vysya Bank
2. Vertical Integration: Moving up or down the value chain (acquiring your
supplier or customer) Eg. A steel company could acquire an iron-ore
mining giant (backward integration)
3. For technology and intellectual property. Google’s acquisition of
Motorola and Tata Steel’s acquisition of Corus.
4. Financial Reasons – tax savings, buying something cheap and selling it
later.
5. Diversification. Eg. ITC’s acquisition of Savlon from Johnson & Johnson
6. Face Competition Better (or at an extreme, overpower and eliminate
competition) Vodafone-Idea merger in the face of Reliance Jio’s
competitive threat
7. Increase Bargaining Power. A larger combined entity will have more
negotiating power than 2 smaller entities.
Process of M&A
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Mergers and Acquisitions
A typical 10-step M&A deal process includes:
1. Develop an acquisition strategy – Developing a good acquisition
strategy revolves around the acquirer having a clear idea of what they
expect to gain from making the acquisition – what their business
purpose is for acquiring the target company (e.g., expand product lines
or gain access to new markets)
2. Set the M&A search criteria – Determining the key criteria for
identifying potential target companies (e.g., profit margins, geographic
location, or customer base)
3. Search for potential acquisition targets – The acquirer uses their
identified search criteria to look for and then evaluate potential target
companies
4. Begin acquisition planning – The acquirer makes contact with one or
more companies that meet its search criteria and appear to offer good
value; the purpose of initial conversations is to get more information
and to see how amenable to a merger or acquisition the target company
is.
5. Perform valuation analysis – Assuming initial contact and
conversations go well, the acquirer asks the target company to provide
substantial information (current financials, etc.) that will enable the
acquirer to further evaluate the target, both as a business on its own
and as a suitable acquisition target
6. Negotiations – After producing several valuation models of the target
company, the acquirer should have sufficient information to enable it
to construct a reasonable offer; Once the initial offer has been
presented, the two companies can negotiate terms in more detail
7. M&A due diligence – Due diligence is an exhaustive process that begins
when the offer has been accepted; due diligence aims to confirm or
correct the acquirer’s assessment of the value of the target company by
conducting a detailed examination and analysis of every aspect of the
target company’s operations – its financial metrics, assets and
liabilities, customers, human resources, etc.
8. Purchase and sale contract – Assuming due diligence is completed with
no major problems or concerns arising, the next step forward is
executing a final contract for sale; the parties make a final decision on
the type of purchase agreement, whether it is to be an asset purchase or
share purchase.
9. Financing strategy for the acquisition – The acquirer will, of course,
have explored financing options for the deal earlier, but the details of
financing typically come together after the purchase and sale
agreement has been signed
10. Closing and integration of the acquisition – The acquisition deal closes,
and management teams of the target and acquirer work together on the
process of merging the two firms.
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Mergers and Acquisitions
Synergies and their types
A synergy is any effect that increases the value of a merged firm above the
combined value of the two separate firms. Synergies may arise in M&A
transactions for several reasons, such as cost savings due to operational
efficiencies or revenue upside due to more productive use of assets.
There are usually three types of synergies in mergers and acquisitions that
occur among companies namely revenue, cost, and financial synergy. Let’s
look at these different types of synergies so that we can understand how
synergy works in different situations.
Revenue synergy
If two companies go through revenue synergy, they happen to sell more
products. For example, let’s say that G Inc. has acquired P Inc. G Inc. has
been in the business of selling old laptops. P Inc. is not a direct competitor
of G Inc., But P Inc. sells new laptops quite cheaply. P Inc. is still very
small in profit and size, but they have been giving great competition to G
Inc. since it is selling new laptops at a much lesser price.
As G Inc. has acquired P Inc., G Inc. has increased its territory from selling
only used laptops to selling new laptops in a new market. By going
through this acquisition, the revenue of both of these companies will
increase, and they would be able to generate more revenue together
compared to what they could have done individually.
Real world example of revenue synergy:
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Mergers and Acquisitions
Cost synergy
The second type of synergy in Mergers is the cost synergies. Cost synergy
allows two companies to reduce costs as a result of the merger or
acquisition. If we take the same example we took above, we would see that
as a result of the acquisition of P Inc., G Inc. is able to reduce the costs of
going to a new territory. Plus, G Inc. is able to get access to a new segment
of customers without incurring any additional cost.
Cost reduction is one of the most important benefits of cost synergy. In
the case of cost synergy, the rate of revenue may not increase; but the
costs would definitely get reduced. In this example, when the cost synergy
happens between G Inc. and P Inc., the combined company is able to save
a lot of costs on logistics, storage, marketing expenses, training expenses
(since the employees of P Inc. can train the employees of G Inc. and viceversa), and also in market research.
That’s why cost synergy is quite effective when the right companies merge
together, or one company acquires another.
Real world example of cost synergy:
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Mergers and Acquisitions
Financial synergy
The third type of synergy in mergers and acquisitions in the Financial
Synergy. If a mid-level company goes to borrow a loan from a bank, the
bank may charge more interest. But what if two mid-level companies
merge and as a result, a large company goes to borrow the loan from the
bank, they will get benefits since they would have better capital structure
and better cash flow to support their borrowings.
Financial synergy is when two mid-sized companies merge together to
create financial advantages.
By going for financial synergy, these two companies not only achieve
financial advantages in the case of borrowing loans or paying less interest,
but they also are able to achieve additional tax benefits. Plus, they are also
able to increase their debt capacity and to reduce the combined cost of
capital.
As an example, we can say that Company L and Company M have merged
to create a financial synergy. Since they are mid-level companies, and if
they operate individually, they need to pay a premium for taking loans
from the banks or would never be able to reduce the cost of capital. That’s
why the merger has turned out to be quite beneficial for both of these
companies, and we can call it financial synergy in Mergers and
Acquisitions.
Important documents in an M&A transaction
Due diligence pitch book
A pitchbook is a sales document created by an investment bank or firm
that details the main attributes of the firm, which is then used by the
firm's sales force to help sell products and services and generate new
clients. Pitch Books are helpful guides for the sales force to remember
important benefits and to provide visual aids when presenting to
clients.The due diligence process helps understand synergies, potential
scalability of the business with enhanced operations and more access to
customers from the buyer's company. Potential buyers will also look at
ways to reduce the overall expenses of the business to increase
profitability.
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Mergers and Acquisitions
Term Sheet
A term sheet is a non-binding document signed by the target and the
prospective buyer that describes the major terms of the proposed
acquisition. While most term sheets are non-binding, they often contain
binding provisions regarding non-solicitation, exclusivity and
confidentiality.
Some deal terms that are commonly negotiated and which appear in a
typical term sheet are mentioned in the table below.
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Mergers and Acquisitions
Non Disclosure Agreements
In merger and acquisition (M&A) transactions, confidential and
proprietary information (such as financial information and important
contracts) often needs to be shared with the other party. But the path to
doing so safely is making sure that the other party is bound to respect the
confidential information provided and not use it to the disclosing party’s
detriment.
One common way to protect the secrecy of confidential information given
to another party is through the use of a Non-Disclosure Agreement, which
is sometimes also referred to as a “Confidentiality Agreement” or “NDA.”
The important elements of Non-Disclosure Agreements include:
Identification of the parties
Definition of what is deemed to be confidential
The scope of the confidentiality obligation by the receiving party
The exclusions from confidential treatment
The obligation to return or destroy confidential information when
requested by the disclosing party
The term of the agreement
Letter of Intent
This non-binding document is the beginning of a merger and acquisition
transaction. The relevance of this document is sometimes not perceived by
the seller. The seller has to consider this document with the same
diligence which he makes for other documents in the transaction. Though
the document is non-binding, some clauses like confidentiality,
exclusivity, governing law and arbitration, termination, fees, and expenses
of the letter of intent are binding. The board of directors must authorize
the execution of the letter of intent.
Acquisition agreement
After this is the acquisition documents. Parties in the transaction will enter
into an acquisition agreement which is a binding document. The
acquisition agreement contains terms of the deal entered between parties.
The main clauses in an acquisition agreement are description,
interpretation, covenants, representations and warranties, conditions,
termination, indemnification, etc. The Acquisition agreement must be
carefully drafted to avoid future disputes or ambiguities.
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Mergers and Acquisitions
Articles of Incorporation
Amendments to the articles of incorporation of the surviving company are
essential. This includes the issuance of any new class of shares if any
according to the acquisition agreement, change in the name of the
company if any, any change in the purpose clause, expansion details by
the company if any, etc.
Role of an Investment banker
1. Identification of the right assets
Benchmark on potential targets
Zero-in on the best fit
2. Valuation of the target
Financial Modelling
Analyze similar precedent transactions, similar companies
3. Due diligence
Check all claims and assumptions - business, financial, legal, etc.
4. Negotiation with the other party
5. Regulatory clearances
Anti-trust
Competition commission and other regulators
6. M&A Roadmap: How to go about the deal
Structure
How to fund the transaction: Debt or Equity
Transaction Characteristics
Forms of an Acquisition:
(a) In a stock purchase, the acquirer provides cash, stock, or
combination of cash and stock in exchange for the stock of
the target firm.
• A stock purchase needs shareholder approval
• Target shareholders are taxed on any gain
• Acquirer assumes target’s liabilities
(b) In an asset purchase, the acquirer buys the assets of the
target firm, paying the target firm directly.
• An asset purchase may not need shareholder
approval
• Acquirer likely avoid assumption of liabilities
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Mergers and Acquisitions
Types of Purchase Consideration
(a) Cash Offering:
• Cash is paid to the shareholders of the target
company for their stocks
(b) Securities Offering:
• Target shareholders receive shares of
common/preferred stock or debt of the acquirer in
exchange of their stocks in the target.
• The exchange ratio determines the number of
securities received in exchange for a share of target
stock
(c) Factors influencing method of payment:
• Sharing of risk among the acquirer and the target
shareholders.
• Signalling by the acquiring firm.
• Capital structure of the acquiring firm.
Types of M&A
(a) Accretive Transaction: An acquisition that will increase the acquiring
company’s earnings per share (EPS)
(b) Dilutive Transaction: An acquisition that will decrease the acquiring
company’s earnings per share (EPS)
Hostile takeover
A hostile takeover is the acquisition of one company (target) by another
(acquirer) that is accomplished by going directly to the company's
shareholders or fighting to replace management to get the acquisition
approved.
A hostile takeover can be accomplished through either a tender offer or a
proxy fight.
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Mergers and Acquisitions
Hostile Takeovers Through Tender Offers
When a company, an investor or a group of investors makes a tender offer
to purchase the shares of another company at a premium above the
current market value, the board of directors might reject the offer.
The acquiring company can take that offer directly to the shareholders,
who may choose to accept it if it is at a sufficient premium to market value
or if they are unhappy with current management. The sale of the stock
only takes place if a sufficient number of stockholders, usually a majority,
agree to accept the offer.
Hostile Takeovers Through Proxy Fights
In a proxy fight, opposing groups of stockholders persuade other
stockholders to allow them to use their shares' proxy votes.
If a company that makes a hostile takeover bid acquires enough proxies, it
can use them to vote to accept the offer.
Defenses against hostile takeovers
To protect against hostile takeovers, a company can establish stocks
with differential voting rights (DVR), where a stock with less voting
rights pays a higher dividend. This makes shares with a lower voting
power an attractive investment.
Establish an employee stock ownership program (ESOP), which is a taxqualified plan in which employees own substantial interest in the
company. Employees may be more likely to vote with management,
which is why this can be a successful defence
sale of the most valuable assets if there is a hostile takeover, thereby
making it less attractive as a takeover opportunity.
A shareholder rights plan, a poison pill defence allows existing
shareholders to buy newly issued stock at a discount if one shareholder
has bought more than a stipulated percentage of the stock
A people pill provides for the resignation of key personnel in the case
of a hostile takeover
Pac-Man defence has the target company aggressively buy stock in the
company attempting the takeover.
Real world example - International beverage company InBev tried to fire
Anheuser Busch’s board of directors in order to gain control. InBev then
offered a premium price on shares, which succeeded in ousting the
reluctant management.
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Mergers and Acquisitions
Friendly takeover
A friendly takeover is the act of the target company's management and
board of directors agreeing to be absorbed by an acquiring company. Such
action is typically subject to approval by both the target company’s
shareholders and the regulatory authorities. Sometimes, a friendly
takeover might not be allowed due to anti monopoly laws. In a friendly
takeover, a public offer of stock or cash is made by the acquiring firm. The
board of the target firm will publicly approve the buyout terms, which
subsequently must be greenlit by shareholders and regulators, in order to
continue moving forward. Friendly takeovers stand in stark contrast to
hostile takeovers, where the company being acquired does not approve of
the buyout, and often fights against the acquisition.
In a majority of cases, if the board approves a buyout offer from an
acquiring firm, the shareholders follow suit, by likewise voting for the
deal’s passage. In most prospective friendly takeovers, the price per share
that's being offered is the chief contemplation, ultimately determining
whether or not a deal is approved.
For this reason, the acquiring company usually strives to extend fair
buyout terms, where it offers to buy shares at a premium to the current
market price. The size of this premium, given the company's growth
prospects, will govern the overall support for the buyout, within the target
company.
Real world example - In December 2017, drugstore chain CVS Health
Corp. (CVS) announced it would acquire health insurer Aetna Inc. (AET)
for $69 billion in cash and stock. Both companies' shareholders approved
the merger on March 13, 2018, bringing the combined organization one
step closer to finalizing a deal that would ultimately transform the
healthcare industry.
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Preparation Tips for IB
Roles
Skills required
Ability to work in a fast-paced, team-based environment with minimal
supervision
Working knowledge of deal structuring and closing principles
Strong communication and networking skills
Excellent research, quantitative and analytical skills
Proficiency in Microsoft Office product - Excel and Powerpoint
Ability to evaluate the impact of events on the financial position of companies
Impeccable Time and Project Management skills
Tips and Tricks for Pre-processes
1. Know your resume in and out. Try to know everything about every point you
write.
2. Doing NPAD diligently is a must. Refer to it before your interviews for
performing well in HR rounds.
3. Maintain formal behaviour and communication even in informal and buddy
rounds. Consider them to be highly evaluative.
4. Go through some basic IB specific questions to get a flavour of what can be
asked. For example, different methods of valuation, enterprise value, beta,
ratios and their interpretation, DuPont analysis, etc.
5. Have clarity regarding concepts of Term-I Finance and Accounting course,
especially how a particular transaction affects all three statements.
6. Be well updated with all the finance and business-related current affairs.
Importance of following a particular sector of your interest cannot be
overstated. Also keep tabs on popular M&A deals and their details.
7. Be confident and clear about what you know and what you don’t. Go through
the questions you couldn't answer in preliminary rounds, answering them in
further rounds will show that you are willing to learn.
8. Read about M&A deals and what parameters are needed to judge and analyze
these deals.
9. Get constant feedback and areas of improvement from mock PIs.
40
Preparation Tips for IB
Roles
Resources
Preparatory Material provided by Placement Preparation Committee
Term-I Finance and Accounting course material
CFA Level 1 notes
Aswath Damodaran’s Youtube Channel and book ‘Valuation’
Investopedia and Corporate Finance Institute to clarify any finance
jargon
CRISIL, CMIE, EuroMonitor, Capitaline for company and industry
reports
Dealcurry, Venture Intelligence, Merger Market for M&A deals
Mint, FT, ET, Hindu BL, etc. financial newspapers
Macroeconomic reports published by WB, IMF, RBI, Banks
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