1. Investment Banking – Introduction April 11, 2017
SMU Finance Club
Investment Banking – Introduction
April 11, 2017

2. Table of Contents Section Background and Overview
Categories of Investment Banks
IBD Organizational Structure
Capital Markets
M&A
Restructuring
Valuation
Analyst Role
SMU AAMC Program
Further Reading
Common Terms and Definitions I II
III IV V VI
VII
VIII IX X XI

3. Background and Overview

4. Background and Overview
Investment banking refers to one of two divisions of the typical investment bank
Two core functions:
Raise capital: serve as an intermediary between entities that need capital (corporations and governments) and entities that supply capital (investors) through capital markets; the investment bank underwrites debt and equity offerings to source capital
Advise on transactions: serve as an advisor on mergers and acquisitions (M&A), restructuring, and other strategic actions

5. Divisions of the Investment Bank
Background and Overview
Divisions of the Investment Bank
IBD
Corp. Fin
Advisory
Capital Markets
S&T
Research
Investment bankers are here
Salespeople, traders, researchers are here
Chinese wall of information

6. Overview – Key U.S. Legislation
Background and Overview
Overview – Key U.S. Legislation
Glass-Steagall Act (1933): separated commercial and investment banking activities
Commercial banking: taking deposits (e.g. checking accounts) and lending
Investment banking: providing advise and capital markets activities, including securities underwriting and sales and trading
Repealed in 1999 during Clinton administration, leading to higher leverage, more conflicts of interest, and more systemic risk through the creation of “universal banks”
Dodd-Frank (2010): a broad set of regulations intended to limit risk in the financial system; created a number of government agencies
Regulates institutions deemed “too big to fail”
Created the Consumer Financial Protection Bureau
Regulates derivatives like credit default swaps
Volcker Rule effectively killed proprietary trading in investment banks

7. Categories of Investment Banks

8. Categories of Investment Banks
Overview
Bulge bracket: the largest fully-integrated institutions that provide a full range of services, from investment banking to research, and sales and trading; these banks can underwrite securities offerings and are often financial conglomerates that include a commercial banking and asset management arms
Independent advisory: large, global firms that often do not have a sales and trading division and focus on providing advise on M&A and restructuring
Full-service middle market: smaller investment banks that offer a full range of services and focus on middle and lower middle market clients
Elite boutique: similar to independent advisories, but smaller and often specialize in an industry
Regional boutique: very small firms with a handful of bankers and a narrow breadth of services offered; often have few offices and are limited to a geographic region

9. Elite boutique: Centerview, Perella Weinberg, Allen & Co., Qatalyst
Categories of Investment Banks
Examples
Bulge bracket: Goldman Sachs, Morgan Stanley, JPMorgan, Citi, BAML, Barclays, Credit Suisse, UBS, Deutsche Bank
Independent advisory: Lazard, Evercore, Blackstone Advisory (PJT Partners), Moelis & Co., Greenhill, Rothschild
Full-service middle market: Jeffries, Houlihan Lokey, Stifel, RBC Capital Markets, William Blair, Piper Jaffray, Cowen Group, Guggenheim
Elite boutique: Centerview, Perella Weinberg, Allen & Co., Qatalyst
Regional boutique: there are hundreds of small boutiques

10. IBD Organizational Structure

11. IBD Organizational Structure
Overview
In the typical bulge bracket investment bank, there are two types of groups
Product groups: differentiated by product type; exposed to multiple industries, with a focus on transaction execution
Coverage groups: cover clients in a specific industry; exposed to multiple deal types, with a focus on client relationships and industry trends
Deal origination falls mostly with coverage groups, while transaction execution falls mostly with product groups; however, the balance varies greatly depending on the bank and the specific deal
It is not true that coverage groups solely perform marketing (pitching) activities and product groups execute transactions

12. Leveraged Finance: structure, execute high-yield debt financing
IBD Organizational Structure
Product Groups
M&A: advise on merger and acquisition transactions, which are the buying, selling, or merging of companies or assets
Restructuring: advising financially distressed companies or their creditors
Leveraged Finance: structure, execute high-yield debt financing
Debt Capital Markets: structure, execute investment-grade debt financing like corporate bonds
Equity Capital Markets: structure, execute equity offerings and equity- derivatives such as IPOs, secondary equity offerings, and equity options

13. Financial Institutions Group (FIG) Energy / Natural Resources
IBD Organizational Structure
Coverage Groups
Healthcare
Financial Institutions Group (FIG)
Energy / Natural Resources
Tech, Media, and Telecom (TMT)
Consumer and Retail (C&R)
Real Estate
Industrials
Financial Sponsors
Gaming and Lodging

14. IV. Capital Markets

15. These bankers raise money for their clients through capital markets
Overview
Bankers in capital markets groups like ECM, DCM, and LevFin are often called corporate finance bankers (as are coverage bankers)
These bankers raise money for their clients through capital markets
They act as the liaison between the trading floor and the bank’s coverage bankers, keeping a pulse on the market
They can provide financing, refinancing, and restructuring of current financing

16. V. M&A

17. M&A embodies creative destruction; it is necessary for economic growth
Overview
M&A includes transactions in which ownership of corporations or assets are transferred or combined
Rather than organically growing a business, a company can simply acquire another or merge to create growth
The goal of M&A is to create the value of a combined company that is greater than the sum of the individual parts
M&A embodies creative destruction; it is necessary for economic growth
Rationale: to realize synergies (e.g. cutting overlapping costs or achieving economies of scale), enter new markets, acquire talent or technology, or simply to become a bigger company (and increase executive pay)
M&A bankers are necessary to transactions, as they “know markets well enough to find buyers, set prices, and structure deals”1
M&A advisors are usually paid a fee as a percentage of the transaction value
1. From Bloodsport by Robert Teitelman; a lot of this section is based on Teitelman’s book

18. 1960’s: merger boom began as the conglomerate model dominated
M&A
Historical Timeline
1950’s: hostile M&A, corporate raids took place in a small, obscure corner of financial markets
1960’s: merger boom began as the conglomerate model dominated
1968: Williams Act attempted to curb conglomerate wave by providing rules for tender offers; sought to protect management; completely backfired and legitimized tender offers, making corporations increasingly transactional
1974: first hostile bid for an NYSE-listed company; Morgan Stanley advised the acquirer; marked shift from balance sheet-oriented to business fit-oriented M&A fueled by financing from investment banks and high-yield debt
1979: American Express launches hostile takeover bid for McGraw-Hill, marking clear shift toward shareholder power over boards and management
1980: by this time, the shame of hostile takeovers disappeared; every major company found itself a part of the M&A game; also, institutional investors began wielding greater power than individual retail investors, focusing on share price
1980’s: deregulation and a strong economy fueled an M&A frenzy; a market for corporate control developed and matured

19. M&A
Ideology Debate
“Takeovers…were never a certainty, despite the jargon and promises of the Wall Street crowd. They represented enormous risk, an experiment at both the microeconomic and macroeconomic level that, unlike a true scientific investigation, could rarely be tested, judged, or quantified, either prospectively or retrospectively. Takeovers, as we shall see, were swaddled in theory” Robert Teitelman, Bloodsport

20. Ideology Debate (cont’d)
M&A
Ideology Debate (cont’d)
Takeover frenzy triggered a debate that peaked in the 1980’s over corporate governance and the value of M&A transactions
Stakeholder model: corporate managers have autonomy and control of the company; companies have a responsibility for all stakeholders, not just shareholders; the firm is something like a fiduciary trust; this model gave way to agency theory and the shareholder model in the 1970’s and 1980’s as free-market ideas proliferated; it is becoming more popular in the wake of corporate failures like WorldCom, Enron, and the 2008 Financial Crisis
Agency theory: transaction costs arise as a natural part of the contracting process; imply that companies are merely a sum of their contracts with employees, vendors, and customers who are unaligned, self-interested agents that can come and go frictionlessly, like shareholders; the “firm” is legal fiction; this is the basis for the shareholder-centric model

21. Ideology Debate (cont’d)
M&A
Ideology Debate (cont’d)
Coasian firm: the firm is a “nexus of contracts” and agency costs
Shareholder model: shareholders are the sole “owners” of the company and the source of power; the obligation and goal of a company is to maximize shareholder value (Friedman)
The market-driven, shareholder model of governance came from financial economists at the University of Chicago, particularly Michael Jensen; this school of thought provided rationale for and set off a wave of unrestrained M&A
M&A is an “accountability mechanism” in the market for corporate control: it disciplines managers with the threat of a takeover and gives shareholders a voice not always provided through the board
Debt is also an “accountability mechanism,” as it forces managers to perform more efficiently; in order to pay interest obligations, managers must be disciplined; “putting pressure on cash flows yields diamonds”

22. Ideology Debate (cont’d)
M&A
Ideology Debate (cont’d)
"They understood how fragile the inner workings of a corporation-- systems , practices, technologies, products, cultures, people--actually were. They saw them as organic entities, with complex lives, psychological and material; individual, diverse, shaped by their pasts, not as abstract nexuses of contracts that could be engineered without cost, reimagined without stress, dissembled, reassembled with frictionless ease." - Robert Teitelman, Bloodsport

23. M&A
Terms and Definitions
Accretive: when the sum of combined companies increases pro-forma earnings per share
Activist: usually a hedge fund that buys minority stakes in companies and presses for strategic actions that would increase the share price, such as M&A, stock buybacks, or change in management; the corporate raiders have branded themselves shareholder activists, and have changed up the playbook slightly
Break-up fee: also known as a termination fee; the amount payable to the acquirer should the target company back out of an acquisition agreement
Bridge loan: short-term loans that are meant to be replaced by permanent financing; provides a bidder with committed financing and bridges time gap between transaction and acquisition financing
Business judgement rule: protects management when they make decisions in M&A situations; boards and managers possess the best information in a transaction and are best positioned to act rationally
Corporate raider: someone who buys a stake in a company intending to perform a hostile takeover or shake up management, resulting in an increase in the stock price

24. Terms and Definitions (cont’d)
M&A
Terms and Definitions (cont’d)
Crown jewel: the target company’s most attractive business unit
Data room: platform for a potential acquirer to access a target company’s financial information and records during the due diligence process
Dilutive: when the sum of combined companies decreases pro-forma earnings per share
Due diligence: the process of learning about the target company, so the acquirer can understand what it is buying; if the target is receiving stock for compensation, the target must perform due diligence on the acquirer
Fairness opinions: in almost every M&A transaction, an independent party is asked to opine on the fairness of the deal to shareholders; independent advisories usually perform this service
Football field: a graph showing the range of implied valuations based on different methodologies
Front-loaded, two-tiered bid: a hostile bid in which the bidder offers to buy enough shares to gain control at a certain price, then offers to buy the remaining shares at a lower price; puts pressure on shareholders to tender their shares quickly

25. Terms and Definitions (cont’d)
M&A
Terms and Definitions (cont’d)
Golden parachute: a defense tactic in which management are guaranteed significant severance compensation in the even of change of control; makes a target more expensive and less attractive
Goodwill: the value of intangible assets on a balance sheet that is created during M&A
Greenmail: shaking down a company by buying a large stake and threatening a hostile takeover; the company agrees to buy back the shares at a premium to make the raider go away
Hostile takeover: when someone makes an unfriendly, unsolicited bid for a company’s shares against the wishes of management; the bidder usually goes straight to shareholders with a tender offer
Material adverse effect: merger agreements have MAE clauses that state if the target turns out to be an unattractive asset, the buyer does not have to close the transaction
NDA: advisors and other parties privy to a transaction agree to keep material non-public information private and are restricted from certain trading activity
Pac-man defense: when the target of a hostile takeover turns around and tries to acquire the company that made the hostile bid

26. Terms and Definitions (cont’d)
M&A
Terms and Definitions (cont’d)
Poison pill: a defensive tactic designed to make the target’s equity less attractive; when triggered, usually gives current shareholders out-of-the-money warrants that significantly dilute equity
Proxy fight: a contest between two adversarial interests who compete to win a shareholder vote; the opposition is usually another group of shareholders, or the board of directors and management
Reverse merger: when a private company buys or merges with a public company, becoming publicly listed without the IPO process
Revlon moment: when a change of control is imminent, the target company is then “in play” and the target’s board has a duty to conduct an auction to sell the company at the highest price
Roll-up: a series of asset or corporate acquisitions by a company in the same line of business
Risk arbitrage: also known as merger arbitrage; buying shares in a target company at a discount to the transaction price; if the deal is completed the difference between the discounted share price and transaction price is captured; the difference is compensation for the risk the deal falls through
SPAC: special purpose acquisition company; a publicly-traded vehicle specifically set up for acquisitions

27. Terms and Definitions (cont’d)
M&A
Terms and Definitions (cont’d)
Spin-off: splitting off a line of business and giving shareholders equity or a dividend
Synergies: the cost savings and other efficiencies projected to materialize after an M&A transaction
Teaser: brief, general, sometimes anonymous description of a company or asset up for sale that is sent out to potential bidders
Tender offer: an offer to purchase shares from shareholders, usually at a premium
White knight: a friendly bidder who makes a competing bid to prevent a hostile bidder from winning control of a target company

28. VI. Restructuring

29. When advising a financially-distressed company there are two sides:
Restructuring
Overview
Restructuring refers to the restructuring of a company’s capital structure or the restructuring and reorganization of a financially-distressed company
When advising a financially-distressed company there are two sides:
Debtor-side: advising the company which owes money
Creditor-side: advising the creditors which seek to recoup the money they lent and/or gain control of the company in Chapter 11 court-supervised reorganization
For more on restructuring, see our Distressed Debt Investing presentation

30. VII. Valuation

31. Valuation is integral to the services offered by investment bankers
Overview
Valuation is integral to the services offered by investment bankers
In any transaction, whether it’s an IPO or an acquisition, a company must be valued in order to determine a fair and reasonable transaction price
Intrinsic valuation: refers to finding a value for a company or asset by assessing its future cash flow, growth potential, and risk
Discounted cash flow (DCF) analysis
Adjusted present value (APV) analysis
Discounted dividends model (DDM)
Relative valuation: refers to finding a value for a company or asset by benchmarking it against market prices
Precedent transactions analysis
Comparable companies analysis
A range of implied valuations for a company or asset is shown visually in a football field

32. VIII. Analyst Role

33. Most of their time will be spent in Microsoft Outlook
Analyst Role
Overview
Analysts are typically recruited from undergraduate schools for a two year program
Analysts perform valuation and other financial analysis (in Excel), create presentation materials (in Powerpoint) and other documents, and support their superiors in any way necessary, including administrative work like setting up conference calls, preparing for meetings, and printing and binding pitchbooks
Most of their time will be spent in Microsoft Outlook
Work from analysts flows upwards through the Associate, VP, Executive Director, and Managing Director; comments and guidance from senior bankers is given to the analysts and associates
In bulge bracket banks, collaboration between different product and coverage groups is often necessary for complex financial transactions

34. As an analyst, you will work 60-100+ hours per week
Analyst Role
Overview (cont’d)
As an analyst, you will work hours per week
Work is intensive, fast-paced, and stimulating
Attention to detail is absolutely critical
Compensation is very lucrative for a first job: $85k base salary (+signing bonus and year-end bonus) is now “street level”
Two-year analyst program is considered a “boot camp” for financial world
Best general training possible in finance industry
Analyst will often leave with attractive exit opportunities and a network of talented, smart, and driven peers

35. Recruiting and Exit Opportunities
Analyst Role
Recruiting and Exit Opportunities
Investment banking analyst classes are primarily filled by returning summer analysts
Recruitment for summer analysts begins in early in the fall of junior year, or sophomore year, for some people
See WSO, Vault guides, as well as ibankingfaq.com for interview prep
Following the two-year contract, a handful of analysts will be promoted directly to associate; everyone else will exit:
Hedge funds, private equity, venture capital
“Into industry:” working in corporate finance or corporate development
Start-ups
Graduate school
Anything else

36. IX. SMU AAMC Program

37. Approximately 50 students are selected each year Entails two classes:
SMU AAMC Program
Overview
“Highly selective honors program for which admission is based on academic performance and rigor, letters of reference, and an interview process; the program consists of two intensive honor level classes dealing with investment banking, private equity, and hedge funds”
Approximately 50 students are selected each year
Entails two classes:
Valuation: case-based class that focuses on valuation methodologies
Hedge funds: focuses on hedge fund theory and investing strategies
Recruiting: take Wall Street Prep course at end of sophomore year; start mock interviews, etc. at the beginning of junior year

38. X. Further Reading

39. Monkey Business - John Rolfe and Peter Troob
Further Reading
Overview
Monkey Business - John Rolfe and Peter Troob
Bloodsport - Robert Teitelman
The Accidental Investment Banker - Jonathan Knee
Barbarians at the Gate - Bryan Borrough and John Helyar
King of Capital - David Carey
The Predators’ Ball - Connie Bruck
The House of Morgan - Ron Chernow
Investment Banking - Josh Rosenbaum and Josh Pearl
New York Times Dealbook
BloombergView Money Stuff - Matt Levine
The Epicurean Dealmaker - Anonymous blogger
Anything from ‘Strategy, Lifestyle, Growth’ section of FC Guide

40. XI. Terms and Definitions

41. Terms and Definitions
Overview
Bakeoff: also called a beauty contest; competing investment bankers will pitch to a company hoping to get the mandate on a transaction
Bought deal: a debt or equity underwriting in which the underwriters buy the entire issue before selling to primary and secondary markets
Disintermediation: when unregulated new rivals take business from traditional intermediaries, like investment banks; intermediaries exist because of market inefficiencies
Road show: management and their bankers travel to different institutional investors to drum up interest in a securities offering or company sale
Turning comments: the process of making changes to a pitchbook based on a senior banker’s mark-ups