WCM Educational Recap #3: Intro to Investment Banking

Recapped by Stanley Wang

Investment Banking:

This week we covered the role of investment banks and investment bankers. Investment bankers advise companies on transactions that can be split into financing and buying/selling other companies. In addition, investment banks act as agents who connect companies with buyers, sellers, and investors

Financing: For financing, investment banks mainly focus on three areas: IPO’s/ equity financing, leveraged finance, and private placements.

Buying/Selling: For buying and selling, the main focus that investment banks cover can be summarized into three main categories, which include: M&A (merger and acquisition), carve-outs, and divestitures for a business.

Again, investment banks advise clients; they do not invest capital for clients.

Investment Banks can help companies with the following four characteristics:

1. Companies don’t have the network and access to investor capital
2. Companies don’t have the marketing expertise to generate an attractive buyer pool once they go public
3. Companies need to grow and don’t know how (or who to acquire)
4. Companies don’t have the right capital structure to optimize growth

Investment banks are usually split into two categories, the bulge brackets, and the boutiques.

Bulge brackets: The bulge bracket investment banks are global, and they are full-service financial institutions with a multitude of products and broad industry expertise. Investment banking is only one of their many services, as they host large retail and wealth management arms. Although they are advisors, they also have a balance sheet from which they actively lend. The bulge brackets investment banks are generally larger than the boutique investment banks.

Example of Bulge Brackets: Bank of America Merrill Lynch, Barclays Capital, Citi, Credit Suisse, Deutsche Bank, Goldman Sachs, J.P. Morgan. Morgan Stanley, and UBS.

Boutiques: Boutique investment banks are relationship-based banks that purely provide independent advisory. They have grown in popularity due to the conflict of interest between advisory and financing arms seen at the Bulge Bracket banks. Some boutique investment banks may have a specific industry focus (e.g., Qatalyst in Technology) or a strong specialization in a specific practice (e.g., Houlihan Lokey in Restructuring).

Example of Boutiques: Evercore, Lazard, PJT Partners, Houlihan Lokey, Moelis & Company, and Rothschild & Co.

Mergers and Acquisitions

M&A (Mergers and Acquisitions) describes the process of companies combining. It is a broad umbrella term for any form of consolidation. Moreover, it is a specialized product role at some major banks.

1. Merger usually happens when two firms of similar size combine, and a new firm is formed after the process.
2. Acquisition: usually refers to times when a larger company acquires a smaller company and integrates the operations.

There are two types of buyers in an M&A situation:

1. Strategic: refers to the purchase of an operating business that is in the same industry or complements the buyer’s current business
2. Sponsor: refers to the purchase of a business by a financial sponsor (private equity firm, V.C. firm), which is typically funded primarily through debt

There three main motivations for buying another company are:

1. Financial: In many cases, companies choose to merge because of “synergies,” which is a concept that implies the combined value of two companies will be greater than the sum of the individual parts. This would help the company gain more market share, increased revenues, lower costs, and more.
2. Strategic: Companies usually want to expand their market share and dominate a market. By buying another company, it helps the company to increase its Market Power (Ability to compete more effectively/more pricing power, etc.)
3. “Fuzzy” Motives: These are not as explicit as the reasons above; these can be considered tax considerations (helps the company pay less tax), diversification (helps the company enter new markets), and more.

There are three ways that M&A can help build these synergies:

1. Revenue: The company will be able to acquire other company’s products and customers; this helps the company increase its customer base and continue to up-sale products to those customers.
2. Cost: The company will be able to spread fixed overhead costs over a larger number of units. Additionally, the production of one good reduces the cost of producing another related good. Moreover, it gives the company more bargaining power with suppliers.
3. Leverage & Tax: The company can save on the tax they pay, as buyers can assume the seller’s debt, which results in a lower interest rate for the company. Additionally, if a company can increase its depreciation charges, it can save on tax costs and increase value.

The difference between Horizontal and Vertical Integration

Horizontal Integration: The process of a company increasing the production of goods or services at the same level of the supply chain.

Vertical Integration: The process of a company gaining ownership and control of multiple levels of its supply chain.

The horizontal decision can be interpreted as a grow-up decision; in contrast, the vertical decision is more of a cost decision; it can be summarized as the growth vs. the cost.

Why may some Mergers fail?

1. Management egos: A larger company means bigger bonuses if compensation is tied to equity. The upper managers could focus too intently on cost-cutting measures and neglect day-to-day business, resulting in lost customers.
2. Acquirer paid too much: The results of the acquirer being paid too much could lead them to overestimate synergies, which leads to synergies often not being large enough to overcome control premium and financing fees.
3. Unsuccessful at integrating corporate cultures: For the two companies merging, a culture clash may happen due to the companies having very different cultures.

Typically, deals only happen when buyer believes it will earn more from the acquisition than it is spending.

The investment banking hierarchy

1. Analyst: Responsible for doing administrative work, industry research, valuation, presentation preparation, and financial modeling. The average work hours per week are 60 to 80 weeks; sometimes, during live deals, the work hour can be up to 100 hours or more in one week.
2. Associate: Responsible for managing analysts, take control over presentations, and leading model work. The average work hours per week are 50 to 70 hours; sometimes, during live deals, the work hour can be up to 100 hours or more in one week.
3. Vice President (VP): Responsible for outward-facing and less hands-on activities such as coordinating entire deal teams and managing workstreams. The average work hours per week are 50–60 hours.
4. Executive Director (ED): Responsible for coordinating team strategy and managing significant client relationships. The work hours per week may vary in this case.
5. Managing Director (MD): Responsible for giving strategic guidance and direction to the board to ensure that the company achieves its financial vision, mission, and long-term goals. The work hours per week may also vary in this case.

The right fit for banking

These are four of the necessary skills in investment banking

Problem Solving and Attention to Detail: Bankers frequently work with power points and excel graphs, so paying attention to small details is essential.

Presentation & Communication: There are many times when bankers need to talk and present their ideas to CEOs or senior managers; bankers need to have professional presentation and communication skills.

Relationship — Building & Networking: As a banker, there are many interactions with teams and clients; therefore, the banker must know how to efficiently and effectively communicate with people.

Resilience: Banking jobs can be very long and stressful; sometimes, bankers have to manage their stress and finish all the work on time.