WCM Educational Recap #3: Intro to Investment Banking and M&A

Recapped by Morgan Tannis

Intro to Investment Banking and M&A

This week we covered investment banking, M&A, recruiting, and heard from WCM Co-Presidents Emma Hristov and Jerry Wu about how they became interested in finance.

Investment Banking

Investment bankers are advisors. They help companies raise capital, buy other companies, or sell themselves. Companies can raise capital through an initial public offering (IPO), leveraged financing, or private placement.

• IPO: When a company sells equity (ownership in the company) in small, equally sized pieces (shares), to be bought and sold by anyone. Cash raised from IPOs is typically used to fuel accelerated growth.
• Leveraged Financing: When a company sells bonds on the open market.
• Private Placement: When a private company sells shares to a closed, pre-selected group of investors.
• M&A: One of the most common types of transactions that investment banks handle. The buying and selling of companies by other companies.
• Divestiture: When a company partially or fully disposes of one of its business units through sale, exchange, closure, or bankruptcy.
• Carve-Out: A carve-out is a partial divestiture of a business unit. The company will sell a minority interest of the given business unit through M&A or an IPO.

Bulge Brackets and Boutiques

• Bulge Bracket: Bulge bracket banks are full-service financial institutions that offer transaction advisory, retail, wealth management, and commercial banking services. Bulge brackets are organized into product and industry groups. Product groups include equity and debt capital markets, leveraged financing, M&A, financial sponsorship, and restructuring. Industry groups include consumer retail, financial institutions (FIG), healthcare, diversified industrials, energy and power, tech media and telecommunications (TMT), and more.
• Boutiques: Boutique banks only offer advisory services and usually target a specific industry or product group.

Management Structure

• Investment banks’ management structure in order of increasing seniority is Analyst, Associate, VP, Director, Executive Director, and Managing Director.
• Analysts are responsible for building financial models and slide decks and attending meetings with clients. Associates are responsible for building more complex financial models and managing a team of Analysts. Upper management is focused on bigger picture strategy and client coverage.

Skills for Banking

• Investment banking is dynamic, so bankers must possess both technical and interpersonal skills to succeed.
• Analytical and communication skills are important, as are attention to detail and the ability to take initiative and work hard.

Sell-Side Advisory

When a bank advises a company that is selling itself to another company, they are the sell-side of an M&A transaction. The sell-side advisory process includes the five following phases.

• Origination: The seller announces their intent to sell their company. They may be selling because they see value in joining or creating a larger organization or because they want to liquidate their ownership.
• Pitching: Investment banks compete for the client’s business. A typical pitch includes an analysis and valuation of the selling company and a rationale for why their bank is best suited to represent the client.
• Outreach: The winning bank markets the client to potential buyers with a teaser and a CIM. A teaser is a one-page introduction to a company and a CIM is a full pitch and financial analysis.
• Due Diligence: The investment bank researches interested buyers to determine the best fit for their clients.
• Bidding: Buyers settle on their final offer for the target and the transaction closes when a final bid is selected by the client and bank. Price and strategic and cultural fit are considered when selecting the right buyer. If the deal closes, the bank receives its advisory fee and starts working on the next deal.

Buy-Side Advisory

On the other side of an M&A transaction, the buy-side, the bank’s client is a company interested in acquiring another company.

• Origination: The buyer announces their intent to buy another company. They may be looking for a target for strategic or value reasons.
• Pitching: Banks compete for the buyer’s business. A typical pitch includes the rationale for why their bank is best suited to represent the client and how they will find the perfect target.
• Outreach: The bank markets the buyer to potential targets.
• Due Diligence: The bank researches interested sellers to determine the best fit for their clients.
• Bidding: The bank assists the buyer in submitting a fairly priced offer. If the deal closes, the bank receives its advisory fee and starts working on the next deal.

IPO Advisory

When a company lists their shares on a stock exchange, they require the advisory services of an investment bank.

• Origination: The company announces its intent to IPO.
• Pitching: Banks compete for the buyer’s business. A typical pitch includes the rationale for why their bank is best suited to guide the client throughout the IPO process.
• Outreach: The outreach phase of the IPO advisory process is called a “roadshow”. On a roadshow, the investment bankers visit other banks, and asset management and investment firms to generate demand for the company’s shares when they list.
• IPO: The company’s shares are issued on the open market and the bank receives their advisory fee.
• Continuing Coverage: Equity research groups at banks analyze the public company on an ongoing basis. Equity research is separate from investment banking.

M&A

Mergers and acquisitions (M&A) is the consolidation of two companies. A merger is the combination of two companies of similar size to create a new company, and an acquisition is the purchase of a smaller company by a larger company. M&A transactions are completed for either strategic or sponsorship reasons.

• Strategic: Strategic M&A occurs between two companies that are projected to be more powerful and profitable operating together rather than separately.
• Sponsorship: The acquisition of a company by a private equity (PE) or venture capital (VC) firm. The sponsor generates growth by streamlining the target’s operations, replacing management, or completing tuck-in acquisitions, and later sells the target for a profit.

M&A Rationale

• Financial: The conclusion that the value of two companies operating together is greater than the sum of the values of the same companies operating separately. The increased value is created by synergies. Types of synergies include revenue, cost, leverage, and tax. Revenue synergies occur when the combined businesses cross-sell and upsell their products to realize increased revenues. Cost synergies occur when the combined companies eliminate redundant processes, staff, or assets, lowering costs and increasing net income. Leverage synergies occur when a buyer takes on the seller’s debt, increasing their interest expense and lowering their taxes.
• Strategic: Integration, access to unique resources, and undervaluation are some of the strategic reasons for M&A transactions. Horizontal integration allows firms in the same industry to capture additional market share and vertical integration allows companies to control multiple parts of the supply chain, lowering supply costs. Access to unique resources allows companies to share patents, people, proprietary technology, and special assets. When the buyer believes that another company is undervalued. They may acquire them to later sell them and generate a profit.
• Fuzzy Motivations: Acquisitions driven by non-business-related desires and egos of management.

Paying for Acquisitions

• Companies pay for acquisitions using either cash, debit, stock, or a combination of these methods.
• If a company has enough cash on its balance sheet and no better investment opportunities, cash can be used to pay for an acquisition.
• If a company takes on debt to complete the deal, they need to ensure that their return earned on the new business is higher than the interest rate on the debt.
• Sometimes, companies pay for acquisitions with their own shares, trading a piece of their business for another business.

M&A Valuation

Estimating the value of M&A transactions is an important part of an investment banker’s job. Earnings per share (EPS) is the core metric by which the value of acquisitions is measured.

• EPS = Net Income / Shares Outstanding
• When post-transaction EPS is higher than pre-transaction EPS, the transaction generated value, and is “accretive”; when it is lower, the transaction destroyed value, and is “dilutive”. Buyers only follow through with acquisitions that are projected to be accretive.
• To estimate post-acquisition EPS, combine both companies’ net income and adjust for synergies and M&A transaction fees. Divide this sum by the sum of the shares of both firms adjusted for changes in shares outstanding.

M&A Examples

Quaker Oats Acquires Snapple

In 1994, Quaker Oats, a food conglomerate known for selling oatmeal and cereal, acquired Snapple, an alternative soft drink manufacturer known for selling ice tea and juice at convenience stores. Quaker had previously completed a successful acquisition of Gatorade and wanted to replicate the same success with Snapple and capitalize on the anticipated growth in the alternative drinks market. Quaker acquired Snapple for $1.7Bn, $1Bn of which, in retrospect, was estimated to be goodwill. At the same time, PepsiCo and Coca-Cola entered the alternative drinks market and the demand for alternative drinks flatlined. This dangerous combination of increased competition and lagging demand forced Quaker to sell Snapple in 1996 for only $300mm, an 82% loss.

• 67% of all M&A transactions destroy value. Common reasons for failed M&A include incorrect merger model assumptions, operational and cultural integration issues, and overpayment.

Facebook Acquires Instagram

In 2012, Facebook acquired Instagram for $1Bn to eliminate competition, move into the mobile space, and increase ad revenue. In nine years, Instagram grew its user base by 3,233% from 30mm to 1Bn users. Now, Instagram generates ¼ of Facebook’s total top line.

Recruiting

• First-year finance internships are generally at smaller firms like start-ups and search funds. The recruiting process is informal, and interviews are behavioral-focused. Your program, GPA, extracurriculars, and high school achievements are differentiating factors, the strongest of which is GPA. Demonstrate to interviewers that you are interested in finance and eager to learn.
• Network a lot, especially with upper-year students that understand the recruiting process. Apply to all applicable internship opportunities posted through the WCM and WIC mailing lists. Use this template for your resume.
• In second year, recruiting is more formalized. There are opportunities at buy-side shops, pension funds, and asset management and accounting firms. Processes start in September and run until April. Technical preparation is important.
• Tailor your interview prep to your sectors of interest: If you want to work in PE, practice LBO and accounting questions. If you want to work in sales and trading, practice macroeconomic, FX, and fixed income questions. Ask upper-year students to mock you and use this question bank to prepare.

Chatting With Jerry Wu and Emma Hristov

This week we chatted with WCM Co-Presidents Jerry Wu and Emma Hristov about where their interest in finance began.

How did you become interested in finance?

Jerry

• For me, I’m a very quantitative person. I’ve always really enjoyed mathematics but wasn’t too interested in highly quantitative roles like trading. I thought that the idea of working with these large corporate entities and doing transactions at a very high level — things that you see on CNBC — as a first-year, made [investment banking] seem so cool to me. That you get to interact with management as a 23-year-old/24-year-old just entering the business is also really cool. Every part of the world has some sort of business element to it and once you learn those skills you never lose them. For me, that’s a very big part of why I wanted to pursue finance.

Emma

• The moment that I realized I wanted to get into finance and specifically banking is when I went on the New York trip in my second year. I had kind of flirted with the idea of finance earlier. I had talked to some people who were working in investment banks but didn’t really understand the potential opportunities there were and also what drew me in until I went on that trip and connected with other people my age. That’s why I think these clubs are so important because you really get to bounce ideas off of each other. It’s just a very candid conversation with people your age. After talking to my friends and older students on the trip about banking and finance in general, I really got sold with the idea of finance and saw banking as a way into it until I did more research through the clubs and realized the perks of banking itself. That’s how it solidified my decision to pursue it.

Where was your first-year internship?

Jerry

• I didn’t have a first-year internship. I wanted to spend more time in Calgary with my friends, so I worked at a bubble tea shop. It was really fun to work with different people and take a chill summer.

Emma

• In my first year, I worked at an insurance company. More so than the actual role itself, I spent a lot of time googling different businesses and at the time I was just trying to figure out what I should do in life. I was looking at sales jobs and different kinds of companies and what kind of roles they offered. It wasn’t anything too finance-related. I know a ton of people who worked at camp or did something else or didn’t work in the first year and still ended up landing a sweet third-year internship. It’s more about what you do with that time. Learning about what you want to do, even if it’s outside of finance. I feel like that’s a good time for reflection.

What did you do last summer and where are you headed next year?

Jerry

• Last summer I was at Scotiabank Global Banking in Calgary doing investment banking in the energy sector. Next summer I’ll be doing full-time at Scotiabank, Toronto. I don’t know what group I’m in yet but hopefully, that’s to be determined very soon.

Emma

• Last summer I worked at Canaccord Genuity in Toronto in their Diversified Investment Banking group. I primarily worked in the cannabis and healthcare space and then also the consumer retail space — a lot of food products. Next year I’m doing the same thing.

Do you have advice for anyone getting into finance?

Jerry

• My biggest piece of advice is that you don’t have to walk down the path that everybody in front of you has laid out for you. This is why it’s so helpful to have all these clubs because you can hear so many different perspectives from different people. Especially for us on WCM, we have so many diverse perspectives and so many people that came from different backgrounds that are all in the same boat here. You don’t have to follow everybody else’s path. You can create your own path. Do what you want to do. Don’t just go into finance because you think “everybody else is doing it, why shouldn’t I”. It should be something that you actually really want to do. And that’s why talking to different people and talking to as many people as you can in different industries is so helpful especially when it comes to finance because it’s so broad. I’m pretty sure Emma and I have very different experiences even though we were both in investment banking. Reach out to different people and decide for yourself. That would be my biggest piece of advice.

Emma

• Keep an open mind and never say no. If an opportunity comes up, the way I learned the most is by always saying yes and always giving it a try. Not always obviously. You have to take into account your responsibilities and how much time you’re willing to put in. The more you say yes, the broader the range of experiences you can pick up from for learning and to apply to new situations. If that’s three different finance clubs, each club is going to have a different experience and a different kind of community that you’ll interact with and you’ll meet more people. If that’s non-finance-related, like a consulting club or another career path that you could be potentially interested in, you never know what you’re going to learn. Even if you learn a little bit about marketing, it’s still super useful to apply that to a finance setting. You’ll talk to someone who’s going into marketing, for example, and they’ll tell you a little bit about something, you’ll google it when you get home and you’ll learn more about it. And then when you get to your finance job, when you’re analyzing a company, all of that is playing into it. If you don’t understand how one aspect of a business works, it’s going to be a shortcoming once you’re actually working.

Key Takeaways

• The function of investment banks is to advise clients on financing and M&A transactions
• The M&A advisory process has five stages: Origination, pitching, outreach, due diligence, and bidding
• The IPO advisory process has five stages: Origination, pitching, outreach (roadshow), IPO, and continuing coverage
• The two types of M&A buyers are strategic buyers and sponsors
• Financial, strategic, and fuzzy reasons motivate M&A transactions
• EPS is the core metric used to value M&A transactions
• Lock in a strong GPA, get involved in clubs, talk to upper-year students, and apply everywhere to land a first or second-year internship