Investment Banking

JOSHUA ROSENBAUM is a Managing Director and Head of the Industrials & Diversified Services Group at RBC Capital Markets, where he also serves on the Management Committee for the U.S. Investment Bank. 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. He is also the co-author of The Little Book of Investing Like the Pros. JOSHUA PEARL is the Founder and Chief Investment Officer of Hickory Lane Capital Management, a long/short equity asset manager. He focuses on public equity investments and special situations utilizing a fundamentals-based approach. From 2011-2020, he served as a Managing Director and Partner at Brahman Capital. 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. He is also the co-author of The Little Book of Investing Like the Pros.

Additional Resources xv

About the Authors xvii

Foreword xxi

Acknowledgments xxiii

Disclaimer xxxi

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 2 Precedent Transactions Analysis 75

Summary of Precedent Transactions Analysis Steps 76

Step I. Select the Universe of Comparable Acquisitions 79

Screen for Comparable Acquisitions 79

Examine Other Considerations 80

Step II. Locate the Necessary Deal-Related and Financial Information 82

Public Targets 82

Private Targets 85

Summary of Primary SEC Filings in M&A Transactions 86

Step III. Spread Key Statistics, Ratios, and Transaction Multiples 88

Calculation of Key Financial Statistics and Ratios 88

Calculation of Key Transaction Multiples 94

Step IV. Benchmark the Comparable Acquisitions 98

Step V. Determine Valuation 98

Key Pros and Cons 99

Illustrative Precedent Transaction Analysis for ValueCo 100

Step I. Select the Universe of Comparable Acquisitions 100

Step II. Locate the Necessary Deal-Related and Financial Information 101

Step III. Spread Key Statistics, Ratios, and Transaction Multiples 103

Step IV. Benchmark the Comparable Acquisitions 111

Step V. Determine Valuation 113

Chapter 3 Discounted Cash Flow Analysis 115

Summary of Discounted Cash Flow Analysis Steps 116

Step I. Study the Target and Determine Key Performance Drivers 120

Study the Target 120

Determine Key Performance Drivers 120

Step II. Project Free Cash Flow 121

Considerations for Projecting Free Cash Flow 121

Projection of Sales, EBITDA, and EBIT 123

Projection of Free Cash Flow 125

Step III. Calculate Weighted Average Cost of Capital 131

Step III(a): Determine Target Capital Structure 132

Step III(b): Estimate Cost of Debt (rd) 133

Step III(c): Estimate Cost of Equity (re) 134

Step III(d): Calculate WACC 138

Step IV. Determine Terminal Value 138

Exit Multiple Method 139

Perpetuity Growth Method 139

Step V. Calculate Present Value and Determine Valuation 141

Calculate Present Value 141

Determine Valuation 143

Perform Sensitivity Analysis 145

Key Pros and Cons 146

Illustrative Discounted Cash Flow Analysis for ValueCo 147

Step I. Study the Target and Determine Key Performance Drivers 147

Step II. Project Free Cash Flow 147

Projection of Sales, EBITDA, and EBIT 149

Step III. Calculate Weighted Average Cost of Capital 154

Step IV. Determine Terminal Value 159

Step V. Calculate Present Value and Determine Valuation 161

Part Two Leveraged Buyouts 167

Chapter 4 Leveraged Buyouts 169

Key Participants 171

Financial Sponsors 171

Investment Banks 172

Bank and Institutional Lenders 174

Bond Investors 175

Private Credit Funds 176

Target Management 176

Characteristics of a Strong LBO Candidate 177

Strong Cash Flow Generation 178

Leading and Defensible Market Positions 178

Growth Opportunities 178

Efficiency Enhancement Opportunities 179

Low Capex Requirements 179

Strong Asset Base 180

Proven Management Team 180

Economics of LBOs 181

Returns Analysis—Internal Rate of Return 181

Returns Analysis—Cash Return 182

How LBOs Generate Returns 182

How Leverage Is Used to Enhance Returns 184

Primary Exit/Monetization Strategies 187

Sale of Business 187

Initial Public Offering 188

Dividends / Dividend Recapitalization 188

Below Par Debt Repurchase 188

LBO Financing: Structure 189

LBO Financing: Primary Sources 192

Secured Debt 192

High Yield Bonds 196

Mezzanine Debt 198

Equity Contribution 199

LBO Financing: Selected Key Terms 202

Security 202

Seniority 202

Maturity 203

Coupon 204

Call Protection 205

Covenants 206

Term Sheets 209

LBO Financing: Determining Financing Structure 212

Chapter 5 LBO Analysis 217

Financing Structure 217

Valuation 218

Step I. Locate and Analyze the Necessary Information 220

Step II. Build the Pre-LBO Model 220

Step II(a): Build Historical and Projected Income Statement through EBIT 221

Step II(b): Input Opening Balance Sheet and Project Balance Sheet Items 224

Step II(c): Build Cash Flow Statement through Investing Activities 226

Operating Activities 226

Step III. Input Transaction Structure 229

Step III(a): Enter Purchase Price Assumptions 229

Step III(b): Enter Financing Structure into Sources and Uses 231

Step III(c): Link Sources and Uses to Balance Sheet Adjustments Columns 232

Uses of Funds Links 235

Step IV. Complete the Post-LBO Model 238

Step IV(a): Build Debt Schedule 238

Step IV(b): Complete Pro Forma Income Statement from EBIT to Net Income 247

Step IV(c): Complete Pro Forma Balance Sheet 250

Step IV(d): Complete Pro Forma Cash Flow Statement 252

Step V. Perform LBO Analysis 254

Step V(a): Analyze Financing Structure 254

Step V(b): Perform Returns Analysis 256

Step V(c): Determine Valuation 260

Step V(d): Create Transaction Summary Page 261

Illustrative LBO Analysis for ValueCo 262

Part Three Mergers & Acquisitions 273

Chapter 6 Sell-Side M&A 275

Auctions 276

Auction Structure 279

Organization and Preparation 279

Identify Seller Objectives and Determine Appropriate Sale Process 279

Perform Sell-Side Advisor Due Diligence and Preliminary Valuation Analysis 281

Select Buyer Universe 281

Prepare Marketing Materials 282

Prepare Confidentiality Agreement 285

First Round 286

Contact Prospective Buyers 286

Negotiate and Execute Confidentiality Agreement with Interested Parties 286

Distribute Confidential Information Memorandum and Initial Bid Procedures Letter 287

Prepare Management Presentation 288

Set Up Data Room 289

Prepare Stapled Financing Package (if applicable) 291

Receive Initial Bids and Select Buyers to Proceed to Second Round 291

Second Round 293

Conduct Management Presentations 293

Facilitate Site Visits 294

Provide Data Room Access and Respond to Diligence Requests 294

Distribute Final Bid Procedures Letter and Draft Definitive Agreement 295

Receive Final Bids 296

Negotiations 300

Evaluate Final Bids 300

Negotiate with Preferred Buyer(s) 300

Select Winning Bidder 300

Render Fairness Opinion (if required) 301

Receive Board/Owner Approval and Execute Definitive Agreement 301

Closing 302

Obtain Necessary Approvals 302

Shareholder Approval 303

Financing and Closing 305

Negotiated Sale 306

Chapter 7 Buy-Side M&A 309

Buyer Motivation 310

Synergies 311

Cost Synergies 312

Revenue Synergies 312

Acquisition Strategies 313

Horizontal Integration 313

Vertical Integration 313

Conglomeration 314

Form of Financing 315

Cash on Hand 316

Debt Financing 316

Equity Financing 317

Debt vs. Equity Financing Summary—Acquirer Perspective 318

Deal Structure 318

Stock Sale 318

Asset Sale 321

Stock Sales Treated as Asset Sales for Tax Purposes 324

Buy-Side Valuation 327

Football Field 327

Analysis at Various Prices 330

Contribution Analysis 331

Merger Consequences Analysis 333

Purchase Price Assumptions 333

Balance Sheet Effects 338

Accretion/(Dilution) Analysis 343

Acquisition Scenarios—I) 50% Stock/50% Cash; II) 100% Cash; and III) 100% Stock 346

Illustrative Merger Consequences Analysis for the BuyerCo/ValueCo Transaction 351

Part Four Initial Public Offerings 373

Chapter 8 Initial Public Offerings 375

Why Do Companies Go Public? 376

Characteristics of a Strong IPO Candidate 378

Attractive Industry 378

Strong Competitive Position 378

Growth Opportunities 379

Moat & Barriers to Entry 380

Healthy Financial Profile 380

Disruptive & Differentiated Solutions 381

Favorable Risk Profile 381

Proven Management Team 382

Key Participants 383

Investment Banks 383

Company Management 386

Current Owners/Investors 387

IPO Investors 387

Lawyers 388

Accountants 388

Exchange Partner 389

IPO Advisors 390

Vendors 390

Selected Key Terms 391

Offering Size 392

Primary/Secondary 393

Overallotment Option, a.k.a. “Greenshoe” 394

Syndicate Structure 395

Lock-up Provision 396

Listing Exchange 396

Gross Spread 397

Dual-Track Process 398

Special Purpose Acquisition Companies (Spac s) 401

Direct Listings 403

Post-IPO Equity Offerings 406

IPO Considerations 407

Nasdaq Appendix 409

Chapter 9 The IPO Process 413

Organization and Preparation 415

Select IPO Team, Exchange Partner and Assign Responsibilities 415

Manage Corporate Housekeeping 418

C Corp vs. Up-C Structure 423

Determine IPO Timing 425

Determine Offering Structure and Preliminary IPO Valuation 426

Host Organizational Meeting 429

Due Diligence, Drafting, and Filing 430

Perform Underwriter Due Diligence 430

Draft and File the Registration Statement 431

Prepare Other Key Transaction and Corporate Governance Documents 436

Coordinate with Equity Research 437

Respond to SEC Comments and File Amended Registration Statement 437

Marketing and Roadshow 438

Prepare Marketing Materials 438

Salesforce Teach-in 439

Conduct Roadshow 440

Build Order Book 443

Pricing and Allocation 445

Price the Offering 445

Allocate Shares to Investors 447

Closing 447

Afterword 449

Bibliography and Recommended Reading 451

Index 457