M&A and Investment Banking - riassunti completi

M&A and investment banking (slides class 1)

History

Initially investment banking consisted of security underwriting: investment bankers bought securities and sold them to the final investor: they were intermediaries. Nowadays, it comprises several activities, such as underwriting bonds and equity; advisory to governments, families and firms; trading on its account; and brokerage on clients’ account.

First European banks emerged in early 12^th century in Genoa, Florence and Venice; while in the 13^th and 14^th centuries the first financial securities emerged in Italy, such as stocks, options and warrants representing ownership and bonds. Initially, there were two figures: the merchant banker and the financier. The merchant banker offered credit to his clients, initially through the acceptance of commercial bills and later on through trade finance, securities and equity; the financier was a lender to the prince, in fact even if usury was forbidden it was possible to end to governments.

In the 15^th century Amsterdam became a major securities exchange (futures and derivatives) and 1637 the first speculative bubble was recorded with the tulip mania. In late 18^th and 19^th major international family investment banks emerged: initially they were private partnerships pooling large amounts of capital to fund governments and they then became universal banks offering financial services and playing a major role in the capitalization of the industrial revolution. In 1815 London emerged as a dominant financial centre in the western world. In mid 1800 New York became the largest securities market in the US and banks became to be sought by the private sector rather than by governments. In 1900 US had surpassed Great Britain as an industrial power.

In 1933 the Glass-Steagall Act separated commercial banks from investment banks because of commercial speculation; the effect was that of creating barriers and cutting income for universal banks. Investment bankers became main corporations’ counsellors. In 1999 Gramm-Leach-Bliley Act repealed the Glass-Steagall Act having the effect of creating global universal banks able to offer a full range of banking services. In 2007 there was the subprime crisis and credit crisis which led to a global crisis; in 2010 and 2011 in EU the sovereign debt crisis started.

Main services offered

Commercial banking is about lending (deposits taking and loans making), your reputation is made on clients you follow and securities you buy. Private equity is about investing money in equity highly leveraged so to get extra returns. When you want to finance acquisitions, you can get money from the market, either debt or equity. Regulation has affected business models, economic growth and technology drive investments. Growth and M&A are positively correlated.

Capital raising (primary markets)

• Equity markets: IPOs, convertible bonds, follow-on offerings, accelerated book buildings, block trades, other hybrid securities.
• Debt markets: investment grade and high yield bond, mortgage-backed securities (MBS), asset-backed securities (ABS).

Trading securities (secondary markets)

• Capital Markets: securities, derivatives, currencies traded either in exchanges (public regulated markets) or in OTCs.

Business models

• Global Universal Banks: Some are Citi, JP Morgan, Deutsche Bank and Bank of America; they have several business segments: Commercial Banking for lending; Investment Banking for strategic advice and help in managing risk; Securities Services to help in optimizing efficiency and mitigating risk; Treasury Services to provide innovative payment, collection and investment management; Asset Management to provide high-quality global investment management to big clients; Private Banking offers a wide range of services.
• Global Investment Banks: Some are Goldman Sachs, Morgan Stanley and Credit Suisse. They have three business segments: Investment Banking, which is client-driven focused, flow-based and capital-efficient; Asset Management offers products across a broad range of investment classes, such as hedge funds, private equity, real estate, commodities, to fixed income products; Private Banking offers advice and solutions to private, corporate and institutional clients.
• Global Boutiques: Some are Lazard and Rothschild. They have two business segments: Financial Advisory on strategic transactions; Asset Management which provides investment management and advisory services.
• Domestic Universal Banks: Some are UniCredit and Intesa San Paolo. They have several business segments: Domestic Commercial Banking which supports and enhances regional and local brands; Corporate and IB which provides financial services both in private and public sector; International Banking are Italian Universal Banks growing in Europe; Asset Management are Italian leading asset management firms; Financial Advisory.
• Local Boutiques: Some are Gruppo Mittel and Banca Leonardo. They are made of professionals with backgrounds in IBs and consulting firms. They are involved in corporate finance transactions as advisors.

While traditional IBs perform banking activities not classifiable as commercial (underwriting and advising, sales and trading), universal banks perform both activities using an integrated approach but a potential conflict of interests may arise as it might use its lending power to force a firm to use its IBs services. Some advantages of the One Bank approach are that it uses the Relationship Manager to advise and give solutions across all asset classes and global markets: private banking, investment banking and asset management; that it involves specialists to address all financial interests; and it gives to its clients access to opportunities usually available only to major corporate clients.

Drivers of banks’ performance

Drivers of Banks’ Performance are regulation, economic growth and new markets, and technology. 1. Regulations: Banks’ profitability is impacted by cyclical effects, such as lower net interested income and higher provisions; and by secular trends, such as higher capital requirements and lower leverage. There is a secular trend towards lower leverage and lighter balance sheets as a result of changes in regulations, especially Basel III (the secular decrease in leverage is estimated to bring an average 4% reduction in RoAE)

2. Global Markets: Emerging markets account for the smallest share but also the fastest growth in the global financial stock. In 1999, cross-border investing was starting, and by 2009 they had grown substantially (1/3 more from USA, almost doubled from Western Europe, almost 6 times in Africa...). The effect was that IBs global services changed to home multinationals; investment and acquisitions from emerging economies in developed markets started to happen.

3. Technology: Access to information changes the rules of the business. IBs’ investments in technology are a barrier to entrance.

M&A and investment banking (slides class 2)

Investment banking client segment

Its clients are corporate, financial institutions, private equity & sovereign wealth funds and governments.

• Corporate: their balance sheet is as follows. In the asset part there are Cash, which is administered through cash management; Assets, through advisory; Financial Investments, through acquisitions and disposals and hedging. In the right side, there are Debt, accumulated through lending, bond and risk management; and Equity, through IPO and follow-on offering.
• Financial Institutions: the asset side is as the one for corporate, with the difference that its assets are Loans, always managed through advisory. As for the right side, they have Deposits, managed through advisory and risk management; and Equity, as before accumulated with IPO and follow-on.

There are different kinds of firm growth. The Organic Growth which happens when the firm invests in new people, technology and products; the Bolt-on Acquisition which happens within the realm of a company’s existing operations; Alliances and Joint Ventures; and Strategic Acquisitions.

Also, there are several types of M&A transactions, such as Overcapacity Deals, Product/Market Extension, Financial deals in which a company sells a division, Geographic Roll-ups, M&A instead of R&D, Industry Convergence Deals.

In order to raise money either you go through equity capital markets raising equity capital, with IPOs, Follow-on offerings, private placements, ABBs; or you go for Debt capital markets raising fixed income capital, with corporate plain vanilla, perpetual debt, mezzanine finance, high-yield bonds, structured finance products, collateralized debt obligations and project finance.

Derivatives are securities whose price is dependent upon underlying assets. They are used either for hedging or for speculation and they are traded on Exchanges or OTCs. They provide leverage, they can be used for pure speculation or for risk management; you are exposed to non-traded underlying assets, such as weather, you can buy options. The derivatives contracts types are forwards, futures, options, warrants and swaps (interest rate or currency).

• Private Equity: it concerns equity not publicly traded but investors and funds make investments directly to private companies or conduct buyouts of public companies making them private by delisting them. Capital for private equity is raised from retail and institutional investors in order to fund new technologies, expand working capital, make acquisitions. The type of private equity investment changes with the firm maturity: initially there is angel investing, then early stage venture capital, then later stage VC, then buyouts. Also, private equity funds have different stages of life: initially they are based on organisation/fund-raising, then on investment, then on management and then on harvest.

In private equity investors, in the form of limited partners (pension funds, individuals, corporations, insurance companies) provide capital; VCs and private equity firms identify opportunities, screen them, transact and close deals, monitor and add value and raise additional funds; lastly portfolio companies use capital to create opportunities and value.

Private equity started in the 19^th century. Highlights: 1960s bull market helps VCs realize harvests; 1970s was a bleak decade for private equity: poor IPO; end 1970s growth in private equity with a boom in 1980s; as more players entered returns started to decline; 2000’s dot-com bubble burst and private equity remained low until its golden age from 2003 to 2007; in 2007-8 it fell again with the subprime crisis.

The Blackstone Group is a private equity firm and it has both tasks in alternative asset management (private equity, real estate, hedge fund solutions, credit businesses, closed end funds) and as financial advisory (M&A, restructuring and reorganization, raising capital).

• Sovereign Wealth Funds: state owned investment funds established from balance of payments surpluses, proceeds of privatizations, fiscal surpluses, and so on. It excludes foreign currency reserve assets held by monetary authorities for monetary policy purposes.
• Governments: with privatization, the government gives up control over a state owned enterprise, by the disposal of shares/equity; either with direct sale of financial assets, or with indirect sale (sale done by a public corporation or government agency), specific case through the restitution of assets to former owner (financial compensation).

In Italy, a huge privatization program started in 1990s until 2000s. The drivers were the need for fiscal adjustment; for developing capital markets and equity culture also through strengthening institutional investors and market infrastructures; for improving corporate efficiency. This process made SOEs’ value added as % of GDP decline from 19% to 2.6% and over €120 billion were sold through trade sale, stable core of shareholders, IPOs and sale to employees.

Sovereign debt management

Sovereign Debt Management: a process of establishing and executing a strategy for managing the government’s debt in order to raise funding, achieve government risk and cost objectives, meet other SDB goals, such as developing and maintaining an efficient market for government securities. Government debt portfolios are usually the largest financial portfolios in a country. Asset and Liability Management is a new frontier of managing the business and financial risk by matching the financial characteristics of the liabilities to the assets. Debt management risks are Market, Credit, Rollover, Liquidity, Settlement and Operational risk.

M&A and investment banking (slides class 3)

Mergers & acquisitions

There exist different types of firm growth: there is the through bolt-on investing in technology, new people and new products; there are acquisitions which happen within the realm of the company’s existing operations; alliances and joint ventures; strategic acquisitions. Lastly, there are different steps in M&A transactions: you start from defining the business strategy; then you either diversify/expand the business or you restructure/redeploy assets/exit the business.

If you decide to expand the business you can grow at organic level or at inorganic level. By choosing the organic level you invest internally (“internal investment make”). Instead by choosing the inorganic growth you look for businesses outside the starting one: M&A, minority investment, outbound joint venture, strategic alliance and contractual relationships.

Instead, if you choose to restructure, redeploy assets or exit from the business there are different options you might take, such as inbound joint venture, sale of minority interests, spin-off (the creation of an independent company through the sale or distribution of new shares of an existing business or division of a parent company), carve-out (partial divestiture of a business unit in which a parent company sells minority interest of a child company to outside investors; the parent profits from the IPO), split-off (shares of a business division, subsidiary or newly affiliated company are transferred to stockholders in exchange for stocks of the parent company), tracking stock (common stock issued by a parent company that tracks the performance of a particular division without having claim on the asset of the division or parent), divest (either Leveraged buy-out, which is the acquisition of another company using a significant amount of borrowed money to meet the cost of acquisition, and the assets of the acquired company are used as collaterals; or by going private; or third part sale), liquidate or financial restructuring.

Economies of scale

M&A strategic objectives: can be achieved when a company acquires a competitor or when acquisition results in lower average manufacturing costs or by elimination of redundancies in the organization. Time to Market is a variant of economies of scale and it extends a product line or enhances a particular business function. Combination of Customer and Supplier happens when a company buys a supplier or vice versa in order to eliminate contractual risk of having outside suppliers or to eliminate the risk of price gouging. Product line diversification in order to diversify business into other areas to change its risk profile. Defensive Acquisitions happen if the acquirer is facing severe downturns in its business and the acquisition may alleviate the cause of the downturn. New and Better Management if an acquirer thinks it can enhance the value of an acquired business by replacing its management. Acquisition of a Control Premium happens because there is the belief that the public trading markets misprice publicly held stocks since their value on the market is that of an individual holder who is not in control. Bidders bid for companies to capture the control premium inherent in the stock which they can then sell and cash the control premium.

There have been several M&A waves, positively correlated with economy’s booms. Look on the slides (page 6) for the years but there has been an evolution of the kind of transactions, going from horizontal mergers (between two companies offering similar products in the same market); vertical mergers (between two companies that previously sold/bought one from the other, with the aim of improving efficiency); diversified conglomerates (mergers between companies not involved in the same business), junk bonds and LBO; mega deals (which involve a great amount of money) and cross border mergers (when target and acquiring companies are in different countries); to shareholder activism, private equity LBO.

Global M&A trends

I CAN’T (slides 9-21)

Emerging giants’ approach to M&A

While the traditional approach has the aim of lowering costs (even if some companies use it to obtain technologies, enter niches or break into new countries), the new approach is to obtain new technologies, brands and consumers in foreign countries.

Also, while in the traditional approach the two companies have the same business model, in the new approach the acquirer is often a low-cost commodity player which wants to acquire a value-added branded-products company. As for the integration speed, in the traditional approach you go fast in the beginning, making several changes and then you slow down; while in the new approach you move slow in the beginning and then go fast when you are closer to the acquisition. The traditional approach is characterized by high executive turnovers and head-cost reduction in the beginning, accompanied by culture clashes and a decline in productivity: things settle down over time. Instead, in the new approach in the beginning there are typically no tensions, which will probably occur in the long-run.

As for the goals, in the traditional approach the buyer has clear short-term objectives but not long-term ones; while in the new approach the opposite holds.

Regulatory context

The approval process for M&A starts with the board of directors.