Basics of Investment Banking, Private Equity & Subprime Crisis

1. Investment Banking
&
Private Equity
&
Subprime Crisis
by
CA. Sunny Sabharwal

2. Today’s Points of Discussion
1. Investment banking
2. Private Equity
3. Sub-prime Crisis & Indian Markets
2

3. Today’s Points of Discussion
1. Investment banking
2. Private Equity
3. Sub-prime Crisis & Indian Markets
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4. Defining IB (if possible!)
 No clear definition as such
 Deal with securities
 Question – What are securities?
 Answer – A fungible, negotiable instrument representing financial value
 Service Corporates, Government, Institutions and HNIs
 Commercial banks primarily cater to general public
 Not as regulated as Commercials (Why?)
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5. Organizational structure of an I-bank
 Corporate Finance
 Underwriting
 Strategic Advisory
― Mergers & Acquisitions
― Private Placements
― Divestitures
 Sales & Trading
 Institutional & Private Clients
 Pitching & cold calls
 Research
 Recommend “buy”, “sell” or “hold”
 Guess what “Contrarians” do!
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6. Organizational structure of an I-bank
 Activities classified in nature:
 Origination –
― Getting Business (have knowledge of products, business)
― Finding Investors
 Execution –
― Due Diligence
― Documentation : Agreements, term sheets
― Financial Analysis (Valuation)
― Prepare Materials for Internal Committees
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7. Organizational structure of an I-bank
 Industry Coverage
 focus on a specific industry such as healthcare, industrials, or technology
 Product Coverage
 focus on financial products, such as mergers and acquisitions, leveraged
finance, equity, and high-grade debt
 Region Coverage
 focus on particular geography (-ies)
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8. IBGamutofServices
INVESTMENT
BANKING
Initial
Public
Offering
(IPOs)
Mergers &
Acquisitions
Private
Equity
Placements
Qualified
Institutional
Placements
(QIPs)
Follow-on
Offerings
Buyback of
Equities
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9. Types of Stock Issues
Issues
Public Issue
IPO
FPO
Rights Issue Bonus Issue
Private
Placement
Preferential
Issue
Qualified
Institutional
Placement
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10. IB Gamut of Services
 Initial Public Offering
 Do we need a primer!!!
 But why go public?
― Fund the growth – purchase another firm using own stock as currency
― Exit option for Promoters
― Ease in raising finance
 Underwriting or Best Efforts
― Most offerings underwritten
― In very small, risky deals on best efforts basis
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11. IB Gamut of Services
 Initial Public Offering
 Pricing
― Since firm going public, no established price
― Banker and company project the company’s future earnings & cash flows
 Normalize the data
― Market data on similar listed companies
― Price set to place the firm’s P/E and M/B ratios in line with publicly traded
firms in the same industry having similar risk and growth prospects
― Conflict of interest - because Banker has an incentive to set a low price :
 to make brokerage customers happy
 to make it easy to sell the issue
 Firm would like price to be high
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12. IB Gamut of Services
 Initial Public Offering
 Process
― Hiring Managers –
 Who gives the best bet!
 Reputation of IB
 Type of Clients – Institutional or Retail
 Support in the post-IPO secondary market
» Reputation of analyst covering the stock
― Due Diligence & Legal
― Marketing
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13. IB Gamut of Services
 Follow-on offerings
 Additional Capital
 Exit option for large shareholders
 Since more shares mean dilution (EPS effect), stock price usually falls on
news of secondary offering
 Less complicated and lengthy than IPO
― Valuation is provided by the market
― Usually same managers/underwriters used
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14. IB Gamut of Services
14
 Mergers & Acquisitions (buy Vs build)
 Why
― New market, new product
― Vertical or Horizontal Integration
― Additional capital
― Reduce competition (when you can’t fight them, join them)
― Strategic Reasons
 Loss-making company having valuable assets
 Process
― Target identification
― Determination of appropriate price
― Structuring the finance

15. IB Gamut of Services
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 Mergers & Acquisitions
 Mode of Acquisition
― Pure Equity
 Equity & Preference
 Special Class (Differential voting rights, dividends or otherwise)
― Leveraged Acquisitions
 Due Diligence
― Approval rights of financiers
― Title to Properties & Assets
― Statutory Dues
― Litigations
― IPR protection

16. Growth of IB
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17. IB Gamut of Services
17
 Private Equity Placements
 Private sale of unregistered securities by a public company to a select
group of individuals or institutions
 SCRA provides that
― When issuer issues securities to a select group of persons not exceeding 49
 Types:
― Preferential allotment: Listed issuer issues shares to a select group
― Qualified institutions placement (QIP): Listed issuer issues shares to
Qualified Institutions Buyers (Public financial institution, Banks, Mutual funds,
FIIs, Venture capital funds, Pension Funds, etc.)

18. Today’s Points of Discussion
1. Investment banking
2. Private Equity
3. Sub-prime Crisis & Indian Markets
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19. Private Equity
 Definition – equity securities in operating companies that are not
publicly traded on a stock exchange
 Why –
 Long investment horizon
 Building businesses and teams
 Facilitating outpacing of competition – through global networks
 Ensuring high standard of Corporate Governance – disclosures, etc.
 Average investment horizon 7-10 years

20. Private Equity
 Private equity activity
 Fund raising
 Investment
 Divestments
 Structure of PE Funds –
 Usually Limited Partnerships
 Managers : General Partners (GPs); Investors : Limited Partners (LPs)
 LPs – Corporates, Pension Funds, Other PE Funds, HNIs
 Compensation of GPs –
 Management fee - 1-2% of invested capital
 Carry - 20% of excess return on fund

21. Private Equity
 Venture capital – investment in companies that have undeveloped
or developing products
 Types –
 Seed stage – Financing provided to research, assess and develop initial
concept
 Start-up stage – Financing for product development and initial
marketing
 Expansion stage – Financing for growth and expansion

22. Private Equity
 What do VCs look for:
 Strong management team
― Good people management and business development skills
― Prior relevant experience
― Commitment – risks taken / capital invested
 Sound business model
― What’s different / USP
― Large customer base
― Sustainable & profitable growth after fully funded

23. Private Equity
 Exit Options:
 Selling stake to strategic investors
― Competitors
 Initial Public Offering (IPO) in India or overseas
 Sale to any other private equity fund or venture capital fund
 Merger with an existing listed company
 Management / Company buy-backs

24.  Valuation Methods
 Income-based Approach
― Discounted Cash Flows
― Dividend Discount Model
 Asset-based Approach
― Net Asset Valuation
 Market Approach
― Relative Valuation
 P/E, P/BV, EV/EBITDA, EV/Sales
 SUBJECTIVITY
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Private Equity

25.  Discounted Cash Flows
 Premise : ownership is essentially a claim on the cash flows
 Process :
― Estimate free cash flows available to all investors
 Historical performance
 Company projections
 Equity research analyst estimates
 Industry data
― Normalize earnings
― Estimate terminal value (TV)
― Using WACC, determine the appropriate discount rate
― Calculate Enterprise Value
25
Private Equity

26. Today’s Points of Discussion
1. Investment banking
2. Private Equity
3. Sub-prime Crisis & Indian Markets
26

27. Sub-prime Crisis
 Description – Pick any newspaper!!!
 Let’s start with the basics
 What is Sub-prime?
― which is not PRIME
 What is Securitization?
― Bundling of securities
― Payments to investors from mortgage payments by borrowers
― Further sold as Collateralized Debt Obligations (CDOs)
 Tranches – maturity, security, rating
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28. Sub-prime Crisis
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Introduction of exotic
loans and relaxed
standards ―>
increase in sub-prime
mortgage lending
Low interest rates
encouraged Wall
Street investors to back
sub-prime loans in
greater quantities
Hedge funds
worldwide borrowed
money to invest heavily
in sub-prime mortgages
Prices go beyond FED’s
tolerance limit. Interest
rates rise and housing
prices fall
Lenders, rating
agencies, and investors
underestimated the
number of loans that
would default.

29.  Who’s fault is it anyway
 Lenders: for their predatory lending practices focused on subprime
mortgage candidates
 Rating Agencies: Overrate the MBS and other derivatives with underlying
securities of little value
 Mortgage brokers: for steering borrowers to unaffordable loans
 Wall Street investors: for backing subprime mortgage loans without first
verifying the security of the portfolio
 Borrowers: for overstating income levels on loan applications and entering
into loan agreements they could not afford
 Government: for lack of oversight
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Sub-prime Crisis

30. 30
Sub-prime Crisis
A Typical Securitization Process

31.  Impact of crisis on Indian market –
 In India, the closeted financial system is not heavily exposed to the
financial crisis
 PM: None can be immune from a global melt down
 But,
― FII Outflows
― SENSEX plunges
― High Inflation
― Liquidity crunch
 Affecting all industries across the board
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Sub-prime Crisis

32. Requisites for Professionals
 Financial knowledge (a must!) – understanding financial statements
 Financial Economics – GDP, Inflation, Money Supply, etc.
 Understanding and tracking markets – Indian & global
 About the industry – industry cycle, major players, business
models, entry/exit barriers, regulatory issues, etc.
 Valuation Methods
 Other skills –
 Networking & Personal Communication
 Computer skills - Financial modeling, Presentations
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33. Books / Sources / Links
 “The Intelligent Investor” by BENJAMIN GRAHAM
 “Investment Banking Explained – An insider’s guide” by MICHEL FLEURIET
 “Principles of Private Firm Valuation” by STANLEY J. FELDMAN
 Any financial newspaper
 www.vccircle.com – For latest in PE world
 www.stockmarketguide.in – For keeping abreast of Stock Market Events
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34. Let’s discuss

35. Thank You
CA. Sunny Sabharwal
+ 9 1 9 9 5 8 6 7 7 7 6 6
sabharwal.sunny@yahoo.com
www.sunnysabharwal.blogspot.com