Investment Banking: Competence revisited

Friday, May 25, 2007

Investment Banking: Competence revisited

Now that you’ve recovered from the shock of Kruelberg Kretin losing the deal of the year, the indignation of losing that job at Blunderstone for that very same reason, you decide to get on with your life, move on, and start crunching a new set of financials for a new dipshit client.

A long term client of the firm, who has grown to be a technology leader in the IT field wants to acquire the industry leader, who is one of the best established firms in the entire sector, a monster of a company, listed on the NYSE with a second listing on the LSE. Oh, and one more thing, this company, call it the target, is ten times larger than the client, call if the acquirer.



You think to yourself quietly as you stare at the blank excel spreadsheet on your screen. The project has just started, so you have been asked to draft a checklist of tasks that will be required to get the work off the ground. According to the staffer, this is part of your development and you are being given the opportunity to “step up”. This translates, of course, into, “as I, the staffer, am meant to be doing this, and really can’t be bothered to, I will ask you to do it by stepping up and doing my work for me”. Reflecting on this deeper meaning for a moment, you come to the conclusion that if you ever had a doubt as to whether the word staffer was synonymous with a piece of shit, there is clearly no doubt any more.

So, you begin to go through what would be necessary to make this project happen. Ok.

You will need comparable companies and precedent transaction analysis for the sector. You will doubtless be required to prepare these. You will then format them nicely. You will then look at what the mean, median, top and bottom quartiles are, until you come up with the number that makes the target’s multiple lower and the acquirer’s higher. You then take this number to your associate and claim success.

You will also need to build DCF (discounted cashflow) models for both the target company and the acquirer. Ok. That’s easy. Both are public companies and have equity research available. You will look at the equity research reports for both companies and find what the consensus valuations that research is predicting are. You will then work back from these valuations and build the models accordingly, from end to beginning, until you have backsolved to the tiniest and most painstaking detail every assumption to magically get to the desired numbers. Once you have done this, you will go to your associate and claim victory once again.

Then, you will use the valuation you have for the target and that for the acquirer to figure out an exchange ratio. This is the number of shares of the acquirer (at the valuation you have “calculated”) that the acquirer will give in exchange for each share in the target (again, at your “valuation”). Simply put, the acquirer will ask the shareholders of the target to now hols its shares instead of the target’s shares they have been holding until now.

Ok. Next step, the shareholders will likely refuse, realizing how much bullshit has gone into the valuation and will ask for hard cash instead of some worthless shares. There will be a crisis moment, and the valuation will “magically” improve. As the shareholders of the target will still only accept cash, rather than throwing in the towel, Rupert will come up with the idea of raising the money needed to buy the target through debt. Why, because that way he gets a percentage of both the full value of the whole deal (hence the inflated valuations) as well as an even bigger percentage of the amount of debt raised. One slight problem. The acquirer will need to raise debt to the tune of ten times its actual size, which is…well…impossible. So, you will spend a few weeks running numbers on how divisions can be sold to raise cash, calling hedge funds to provide money and so on, until Rupert, who will have come back from holiday, will finally focus on the matter at hand, and officially recognise that this is not doable, and thus will tell the client that this idea will never work.

Minor correction actually. This wasn’t the client’s idea in the first place, so Rupert will not call the client to pitch the brilliant idea.

Now isn’t i-banking the beautiful game or what.

1 comment: