Investment Banking

JOSHUA ROSENBAUM is a Managing Director and Head of the Industrials & Diversified Services Group at RBC Capital Markets. He originates, structures, and advises on M&A, corporate finance, and capital markets transactions. Previously, he worked at UBS Investment Bank and the International Finance Corporation, the direct investment division of the World Bank. He received his AB from Harvard and his MBA with Baker Scholar honors from Harvard Business School. JOSHUA PEARL has served as a Managing Director at Brahman Capital, a long/short equity asset manager. He focuses on public equity investments and special situations utilizing a fundamentals-based approach. Previously, he structured high yield financings, leveraged buyouts, and restructurings as a Director at UBS Investment Bank. Prior to UBS, he worked at Moelis & Company and Deutsche Bank. He received his BS in Business from Indiana University's Kelley School of Business.

Instructor and Student Resources xv

About the Authors xix

About the Editors xxi

Foreword xxiii

Acknowledgments xxv

Disclaimer xxxiii

Introduction 1

Structure of the Book 3

Part One: Valuation (Chapters 1–3) 3

Part Two: Leveraged Buyouts (Chapters 4 & 5) 5

Part Three: Mergers & Acquisitions (Chapters 6 & 7) 6

Part Four: Initial Public Offerings (Chapters 8 & 9) 8

ValueCo Summary Financial Information 9

Part One Valuation 11

Chapter 1 Comparable Companies Analysis 13

Summary of Comparable Companies Analysis Steps 14

Step I. Select the Universe of Comparable Companies 17

Study the Target 17

Identify Key Characteristics of the Target for Comparison Purposes 18

Screen for Comparable Companies 22

Step II. Locate The Necessary Financial Information 23

SEC Filings: 10-K, 10-Q, 8-K, and Proxy Statement 24

Equity Research 25

Press Releases and News Runs 26

Financial Information Services 26

Summary of Financial Data Primary Sources 27

Step III. Spread Key Statistics, Ratios, and Trading Multiples 28

Calculation of Key Financial Statistics and Ratios 28

Supplemental Financial Concepts and Calculations 42

Calculation of Key Trading Multiples 47

Step IV. Benchmark the Comparable Companies 50

Benchmark the Financial Statistics and Ratios 50

Benchmark the Trading Multiples 50

Step V. Determine Valuation 51

Valuation Implied by EV/EBITDA 52

Valuation Implied by P/E 52

Key Pros and Cons 54

Illustrative Comparable Companies Analysis for ValueCo 55

Step I. Select the Universe of Comparable Companies 55

Step II. Locate the Necessary Financial Information 57

Step III. Spread Key Statistics, Ratios, and Trading Multiples 57

Step IV. Benchmark the Comparable Companies 69

Step V. Determine Valuation 74

Chapter 1 Questions 75

Chapter 2 Precedent Transactions Analysis 79

Summary of Precedent Transactions Analysis Steps 80

Step I. Select the Universe of Comparable Acquisitions 83

Screen for Comparable Acquisitions 83

Examine Other Considerations 84

Step II. Locate the Necessary Deal-Related and Financial Information 86

Public Targets 86

Private Targets 89

Summary of Primary SEC Filings in M&A Transactions 90

Step III. Spread Key Statistics, Ratios, and Transaction Multiples 92

Calculation of Key Financial Statistics and Ratios 92

Calculation of Key Transaction Multiples 98

Step IV. Benchmark the Comparable Acquisitions 102

Step V. Determine Valuation 102

Key Pros and Cons 103

Illustrative Precedent Transaction Analysis for ValueCo 104

Step I. Select the Universe of Comparable Acquisitions 104

Step II. Locate the Necessary Deal-Related and Financial Information 105

Step III. Spread Key Statistics, Ratios, and Transaction Multiples 107

Step IV. Benchmark the Comparable Acquisitions 115

Step V. Determine Valuation 117

Chapter 2 Questions 118

Chapter 3 Discounted Cash Flow Analysis 123

Summary of Discounted Cash Flow Analysis Steps 124

Step I. Study the Target and Determine Key Performance Drivers 128

Study the Target 128

Determine Key Performance Drivers 128

Step II. Project Free Cash Flow 129

Considerations for Projecting Free Cash Flow 129

Projection of Sales, EBITDA, and EBIT 131

Projection of Free Cash Flow 133

Step III. Calculate Weighted Average Cost of Capital 139

Step III(a): Determine Target Capital Structure 140

Step III(b): Estimate Cost of Debt (r d) 141

Step III(c): Estimate Cost of Equity (r e) 142

Step III(d): Calculate WACC 146

Step IV. Determine Terminal Value 146

Exit Multiple Method 147

Perpetuity Growth Method 147

Step V. Calculate Present Value and Determine Valuation 149

Calculate Present Value 149

Determine Valuation 151

Perform Sensitivity Analysis 153

Key Pros and Cons 154

Illustrative Discounted Cash Flow Analysis for ValueCo 155

Step I. Study the Target and Determine Key Performance Drivers 155

Step II. Project Free Cash Flow 155

Projection of Sales, EBITDA, and EBIT 157

Step III. Calculate Weighted Average Cost of Capital 162

Step IV. Determine Terminal Value 167

Step V. Calculate Present Value and Determine Valuation 169

Chapter 3 Questions 174

Part Two Leveraged Buyouts 179

Chapter 4 Leveraged Buyouts 181

Key Participants 183

Financial Sponsors 183

Investment Banks 184

Bank and Institutional Lenders 186

Bond Investors 187

Private Credit Funds 188

Target Management 188

Characteristics of a Strong LBO Candidate 189

Strong Cash Flow Generation 190

Leading and Defensible Market Positions 190

Growth Opportunities 190

Efficiency Enhancement Opportunities 191

Low Capex Requirements 191

Strong Asset Base 192

Proven Management Team 192

Economics of LBOs 193

Returns Analysis—Internal Rate of Return 193

Returns Analysis—Cash Return 194

How LBOs Generate Returns 194

How Leverage Is Used to Enhance Returns 196

Primary Exit/Monetization Strategies 199

Sale of Business 199

Initial Public Offering 200

Dividends / Dividend Recapitalization 200

Below Par Debt Repurchase 200

LBO Financing: Structure 201

LBO Financing: Primary Sources 204

Secured Debt 204

High Yield Bonds 208

Mezzanine Debt 210

Equity Contribution 211

LBO Financing: Selected Key Terms 214

Security 214

Seniority 214

Maturity 215

Coupon 216

Call Protection 217

Covenants 218

Term Sheets 221

LBO Financing: Determining Financing Structure 224

Chapter 4 Questions 229

Chapter 5 LBO Analysis 233

Financing Structure 233

Valuation 234

Step I. Locate and Analyze the Necessary Information 236

Step II. Build the Pre-LBO Model 236

Step II(a): Build Historical and Projected Income Statement through EBIT 237

Step II(b): Input Opening Balance Sheet and Project Balance Sheet Items 240

Step II(c): Build Cash Flow Statement through Investing Activities 242

Operating Activities 242

Step III. Input Transaction Structure 245

Step III(a): Enter Purchase Price Assumptions 245

Step III(b): Enter Financing Structure into Sources and Uses 247

Step III(c): Link Sources and Uses to Balance Sheet Adjustments Columns 248

Uses of Funds Links 251

Step IV. Complete the Post-LBO Model 254

Step IV(a): Build Debt Schedule 254

Step IV(b): Complete Pro Forma Income Statement from EBIT to Net Income 263

Step IV(c): Complete Pro Forma Balance Sheet 266

Step IV(d): Complete Pro Forma Cash Flow Statement 268

Step V. Perform LBO Analysis 270

Step V(a): Analyze Financing Structure 270

Step V(b): Perform Returns Analysis 272

Step V(c): Determine Valuation 276

Step V(d): Create Transaction Summary Page 277

Illustrative LBO Analysis for ValueCo 278

Chapter 5 Questions 288

Part Three Mergers & Acquisitions 293

Chapter 6 Sell-Side M&A 295

Auctions 296

Auction Structure 299

Organization and Preparation 299

Identify Seller Objectives and Determine Appropriate Sale Process 299

Perform Sell-Side Advisor Due Diligence and Preliminary Valuation Analysis 301

Select Buyer Universe 301

Prepare Marketing Materials 302

Prepare Confidentiality Agreement 305

First Round 306

Contact Prospective Buyers 306

Negotiate and Execute Confidentiality Agreement with Interested Parties 306

Distribute Confidential Information Memorandum and Initial Bid Procedures Letter 307

Prepare Management Presentation 308

Set Up Data Room 309

Prepare Stapled Financing Package (if applicable) 311

Receive Initial Bids and Select Buyers to Proceed to Second Round 311

Second Round 313

Conduct Management Presentations 313

Facilitate Site Visits 314

Provide Data Room Access and Respond to Diligence Requests 314

Distribute Final Bid Procedures Letter and Draft Definitive Agreement 315

Receive Final Bids 316

Negotiations 320

Evaluate Final Bids 320

Negotiate with Preferred Buyer(s) 320

Select Winning Bidder 320

Render Fairness Opinion (if required) 321

Receive Board/Owner Approval and Execute Definitive Agreement 321

Closing 322

Obtain Necessary Approvals 322

Shareholder Approval 323

Financing and Closing 325

Negotiated Sale 326

Chapter 6 Questions 328

Chapter 7 Buy-Side M&A 331

Buyer Motivation 332

Synergies 333

Cost Synergies 334

Revenue Synergies 334

Acquisition Strategies 335

Horizontal Integration 335

Vertical Integration 335

Conglomeration 336

Form of Financing 337

Cash on Hand 338

Debt Financing 338

Equity Financing 339

Debt vs. Equity Financing Summary—Acquirer Perspective 340

Deal Structure 340

Stock Sale 340

Asset Sale 343

Stock Sales Treated as Asset Sales for Tax Purposes 346

Buy-Side Valuation 349

Football Field 349

Analysis at Various Prices 352

Contribution Analysis 353

Merger Consequences Analysis 355

Purchase Price Assumptions 355

Balance Sheet Effects 360

Accretion/(Dilution) Analysis 365

Acquisition Scenarios—I) 50% Stock/50% Cash; II) 100% Cash; and III) 100% Stock 368

Illustrative Merger Consequences Analysis for the BuyerCo / ValueCo Transaction 373

Chapter 7 Questions 394

Part Four Initial Public Offerings 399

Chapter 8 Initial Public Offerings 401

Why Do Companies Go Public? 402

Characteristics of a Strong IPO Candidate 404

Attractive Industry 404

Strong Competitive Position 404

Growth Opportunities 405

Moat & Barriers to Entry 406

Healthy Financial Profile 406

Disruptive & Differentiated Solutions 407

Favorable Risk Profile 407

Proven Management Team 408

Key Participants 409

Investment Banks 409

Company Management 412

Current Owners / Investors 413

IPO Investors 413

Lawyers 414

Accountants 414

Exchange Partner 415

IPO Advisors 416

Vendors 416

Selected Key Terms 417

Offering Size 418

Primary / Secondary 419

Overallotment Option, a.k.a. “Greenshoe” 420

Syndicate Structure 421

Lock-up Provision 422

Listing Exchange 422

Gross Spread 423

Dual-Track Process 424

Special Purpose Acquisition Companies (SPACs) 427

Direct Listings 429

Post-IPO Equity Offerings 432

IPO Considerations 433

Chapter 8 Questions 435

Nasdaq Appendix 439

Chapter 9 The IPO Process 443

Organization and Preparation 445

Select IPO Team, Exchange Partner, and Assign Responsibilities 445

Manage Corporate Housekeeping 448

c corp vs. Up-c Structure 453

Determine IPO Timing 455

Determine Offering Structure and Preliminary IPO Valuation 456

Host Organizational Meeting 459

Due Diligence, Drafting, and Filing 460

Perform Underwriter Due Diligence 460

Draft and File the Registration Statement 461

Prepare Other Key Transaction and Corporate Governance Documents 466

Coordinate with Equity Research 467

Respond to SEC Comments and File Amended Registration Statement 467

Marketing and Roadshow 468

Prepare Marketing Materials 468

Salesforce Teach-in 469

Conduct Roadshow 470

Build Order Book 473

Pricing and Allocation 475

Price the Offering 475

Allocate Shares to Investors 477

Closing 477

Chapter 9 Questions 479

Solutions to Selected Questions 485

Afterword 513

Bibliography and Recommended Reading 515

Index 521