Business & Economics/Banks & Banking Making Everything Easier!™ n t e m e s t v The keys you need to know I n Open the book and find: I about investment banking n v • What investment banking is Want to expand your knowledge or learn what you need and how it works e k i n g n to know to ace your investment banking course? This in-depth s B a • The role of investment bankers guide takes a comprehensive approach to the topic t in mergers and acquisitions of investment banking so you can discover everything m • How to use important corporate you’ll need to know to apply your knowledge in the filing documents e real world. n • The uses of financial statements • Get started with investment banking — find out what t • Details on performing investment bankers do and how they facilitate financing, discounted cash flow analysis B mergers, and acquisitions a • Dig in — discover the hidden truth in financial statements, • A thorough overview of fixed where to find and read the reports you’ll need, and how to income n perform industry analysis • How to determine a company’s k • Take it to the next level — dig into the details of discounted cash return on equity i n flow analysis, structuring a leveraged buyout, and determining • Case studies to help reinforce return on equity g your reading • Apply investment banking — understand the past of investment banking and new regulations that define the rules of the game Cover Image: ©iStockphoto.com/Danil Melekhin • Fill your tool box — discover the best online resources for Learn to: investment bankers, ways to improve your analysis, and other important tools and tips • Grasp and apply the fundamentals of investment banking • Understand post-financial Matt Krantz is the stock market and IPO reporter for USA TODAY, crisis changes covering financial markets and Wall Street. Robert R. Johnson, Go to Dummies.com® PhD, CFA, CAIA, is a Professor of Finance at Creighton University, for videos, step-by-step photos, • Score higher in your investment where he teaches in the Master of Security Analysis and Portfolio how-to articles, or to shop! banking course Management Program. $26.99 USA / $31.99 CAN / £19.99 UK Matthew Krantz ISBN:978-1-118-61577-5 Author of Investing Online For Dummies 52699 Robert R. Johnson, PhD, CFA, CAIA Krantz 9 781118615775 Johnson Professor of Finance, Creighton University Get More and Do More at Dummies.com ® At home, at work, or on the go, Start with FREE Cheat Sheets Cheat Sheets include Dummies is here to help you • Checklists • Charts go digital! • Common Instructions • And Other Good Stuff! 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Investment Banking by Matthew Krantz and Robert R. Johnson, PhD, CFA, CAIA Investment Banking For Dummies® Published by: John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030-5774, www.wiley.com Copyright © 2014 by John Wiley & Sons, Inc., Hoboken, New Jersey Published simultaneously in Canada No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning or otherwise, except as p ermitted under Sections 107 or 108 of the 1976 United States Copyright Act, without the prior written permission of the Publisher. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions. 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Library of Congress Control Number: 2013954075 ISBN 978-1-118-61577-5 (pbk); ISBN 978-1-118-61570-6 (ebk); ISBN 978-1-118-61571-3 (ebk); ISBN 978-1-118-61588-1 (ebk) Manufactured in the United States of America 10 9 8 7 6 5 4 3 2 1 Contents at a Glance Introduction ................................................................ 1 Part I: Getting Started with Investment Banking ............ 5 Chapter 1: Introducing Investment Banking ...................................................................7 Chapter 2: The Purpose of Investment Banking: What Investment Bankers Do......23 Chapter 3: How Investment Bankers Sell Companies .................................................43 Chapter 4: How Investment Banking Is Used in Mergers and Acquisitions .............61 Chapter 5: How Investment Banking Is Used in Leveraged Buyouts.........................79 Part II: Digging In: Performing Investment Banking ..... 93 Chapter 6: Finding the Data: Documents and Reports ................................................95 Chapter 7: Making Sense of Financial Statements .....................................................113 Chapter 8: Perfecting the Financial Ratios for Investment Banking ........................133 Chapter 9: Sizing Up the Industry ................................................................................151 Chapter 10: Understanding Stocks and Focusing on Past Transactions ................169 Chapter 11: Applying Investment Banking to Fixed Income.....................................183 Part III: Taking Investment Banking to the Next Level ...201 Chapter 12: Doing a Discounted Free Cash Flow Analysis .......................................203 Chapter 13: Structuring a Leveraged Buyout .............................................................223 Chapter 14: Determining the Strength of a Company’s Return on Equity ..............237 Part IV: Applying Investment Banking ...................... 253 Chapter 15: Knowing the Rules ....................................................................................255 Chapter 16: Seeing How Some Companies Lie, Cheat, and Steal Their Way to the Top ..................................................................................................269 Chapter 17: Understanding Alternative Investments and Asset Management ......289 Chapter 18: Trying Your Hand at Investment Banking with a Case Study .............303 Part V: The Part of Tens ........................................... 315 Chapter 19: Ten of the Biggest Debacles in Investment Banking History ..............317 Chapter 20: Ten Ways to Improve a Discounted Cash Flow Analysis .....................325 Chapter 21: Ten (Or So) of the Best Online Resources for Investment Bankers ......333 Appendix: Where Investment Banking Came From ...... 341 Index ...................................................................... 349 Table of Contents Introduction ................................................................. 1 About This Book ..............................................................................................1 Foolish Assumptions .......................................................................................3 Icons Used in This Book .................................................................................3 Beyond the Book .............................................................................................4 Where to Go from Here ...................................................................................4 Part I: Getting Started with Investment Banking ............ 5 Chapter 1: Introducing Investment Banking . . . . . . . . . . . . . . . . . . . . . . . 7 What Investment Banking Is ...........................................................................8 The role investment banking plays .....................................................8 How investment banking differs from traditional banking .............10 The services investment banks provide ...........................................11 How investment banks are organized ...............................................12 The current lay of the investment banking land ..............................14 Types of investment banking operations .........................................15 How investment banks get paid .........................................................15 How Investment Banking Is Done ................................................................17 Finding the financial statements ........................................................17 Understanding the importance of financial statements and ratios .........................................................................................18 Zeroing in on past transactions .........................................................18 Seeing the value of fixed income........................................................19 Turning Into an Investment Banking Pro ....................................................19 Putting the discounted cash flow analysis to work .........................19 Seeing how leverage becomes a force in investment banking .......20 Pinpointing buyout targets .................................................................20 Putting Investment Banking to Work ..........................................................21 Staying in compliance with the rules ................................................21 Looking beyond the published financial statements ......................21 Making adjustments to financial statements for comparability ...................................................................................22 Chapter 2: The Purpose of Investment Banking: What Investment Bankers Do . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 Putting the For-Sale Sign on Corporate America .......................................24 Mergers and acquisitions ...................................................................25 Leveraged buyouts ..............................................................................28 Private business sales .........................................................................30 Initial public offerings .........................................................................32 vi Investment Banking For Dummies Helping Investors Decide Whether to Buy or Sell .....................................36 The importance of research ...............................................................36 What do the analysts do?....................................................................37 Digging Into the Role of the Trading Desk ..................................................38 Why investment banks are into trading ............................................39 How investment banks turn pennies into billions ...........................40 The type of analysis used in trading operations .............................41 Chapter 3: How Investment Bankers Sell Companies . . . . . . . . . . . . . 43 Getting Companies Ready for Sale on Public Markets ..............................44 Meeting the requirements to make an IPO happen .........................45 Writing the prospectus .......................................................................47 Supporting the IPO: Making success last ..........................................51 Seeing What Sell-Side Analysts Do ..............................................................53 The goals of the sell-side analyst .......................................................53 What investors look to sell-side analysts for ...................................54 Spreading the word: Disseminating sell-side research ...................55 Examining a Sample Research Report ........................................................56 What to look for in the document ......................................................56 The main sections of a research report ............................................57 Ways to look beyond the “buy” or “sell” ..........................................59 Chapter 4: How Investment Banking Is Used in Mergers and Acquisitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61 Come Here Often? The Basics of Mergers and Acquisitions ....................61 Kinds of mergers ..................................................................................62 Why companies merge instead of simply growing organically .........................................................................................63 Firms that make attractive acquisition targets ................................66 How companies identify firms to merge with ..................................67 The nature of the merger: Friendly or hostile? ................................68 Tools Used to Analyze the M&A Deal .........................................................71 The role of the buy-side M&A advisor ..............................................71 The role of the sell-side M&A advisor ...............................................74 Why Many M&A Deals Go Wrong ................................................................75 Misplaced incentives ...........................................................................75 Faulty analysis ......................................................................................76 Overstated synergies...........................................................................77 Culture wars .........................................................................................77 The winner’s curse: Overpaying ........................................................78 Chapter 5: How Investment Banking Is Used in Leveraged Buyouts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79 In This Corner: Introducing the Players .....................................................80 Investment banks .................................................................................81 Big institutions .....................................................................................82 vii Table of Contents Management .........................................................................................83 Stock and bond investors ...................................................................84 Aiming for the Right Targets in a Leveraged Buyout ................................85 Identifying companies that can work in a leveraged buyout .........85 Appreciating the power of cash flow ................................................87 Coming to terms with the return analysis: Internal rate of return .....................................................................................88 Finding the Exit ..............................................................................................90 Setting a target for exit in time ...........................................................90 Considering how the exit will happen ...............................................90 Part II: Digging In: Performing Investment Banking ...... 93 Chapter 6: Finding the Data: Documents and Reports . . . . . . . . . . . . . 95 Finding What You Need on the Securities and Exchange Commission’s Website ............................................................96 What types of information you can find ...........................................96 The key types of documents ..............................................................97 How to use EDGAR to pinpoint information .....................................98 Getting Data in a Format You Can Work With .........................................103 Assembling the tools you need ........................................................103 Importing financial information into Excel .....................................105 Getting in tune with interactive data ...............................................106 Paying Attention to the Non-Financial Information .................................107 Monitoring news streams for investment banking ideas ..............107 Quickly processing information with aggregators ........................109 Doing research on the key players in a deal ..................................111 Chapter 7: Making Sense of Financial Statements . . . . . . . . . . . . . . . 113 Income Statements ......................................................................................114 Locating the areas of interest to investment bankers ..................116 Tweaking the statement with different assumptions ....................117 Finding investment banking opportunities ....................................118 Balance Sheets .............................................................................................119 Finding your way around the key parts ..........................................120 Understanding a company’s financial strength .............................122 Locating pitfalls and opportunities .................................................124 Statement of Cash Flows .............................................................................124 Seeing why the cash flow statement is so important in deal making .................................................................................125 Understanding the key parts of the document ..............................125 Calculating free cash flow .................................................................128 Proxy Statements .........................................................................................128 Learning about the key players in a deal ........................................129 Identifying the management team’s incentives .............................130 Analyzing management pay packages .............................................131 viii Investment Banking For Dummies Chapter 8: Perfecting the Financial Ratios for Investment Banking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 133 Valuation Multiples: Assessing How Much the Company Is Worth ......134 Investors’ favorite valuation tool: P/E ratio ...................................134 Going old school with price-to-book ...............................................135 Putting a price on profitability .........................................................136 Liquidity Multiples: Checking Companies’ Staying Power .....................138 Deciphering debt to equity ...............................................................139 Getting up to speed with the quick ratio ........................................140 Interpreting interest coverage .........................................................140 Profitability Ratios: Seeing How a Company’s Bottom Line Measures Up.....................................................................................141 Why gross margin isn’t so gross after all........................................142 Income from continuing operations: Looking at profit with a keen eye ....................................................................142 Keying into profits with net margin .................................................143 Efficiency Ratios: Knowing How Well the Company Is Using Investors’ Money ...........................................................................144 Finding out about return on assets .................................................145 Digging into return on capital ..........................................................146 Uncovering company secrets with return on equity ....................148 Calculating a company’s growth rate ..............................................148 Chapter 9: Sizing Up the Industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 151 Performing an Industry Analysis ...............................................................152 Understanding why industry analysis is important ......................152 Creating a comparison universe ......................................................153 Adjusting the industry comparison universe .................................157 Unearthing Company Trends and Common sizing the Financial Statements .........................................................................158 Comparing growth rates ...................................................................158 Comparing leverage ...........................................................................161 Comparing various profit margins...................................................162 Seeing How a Company Stacks Up: Comparing the Key Ratios .............164 Sizing up valuation .............................................................................164 Comparing total debt-to-equity ........................................................167 Sizing up companies on their efficiency .........................................167 Industry ratios ....................................................................................168 Chapter 10: Understanding Stocks and Focusing on Past Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 169 Introducing Stock ........................................................................................170 Characteristics of stock ....................................................................170 Types of stock ....................................................................................172 Understanding stock pricing ............................................................173