Investment Banking and Corporate Finance Fundamentals
International Financial Markets
International financial markets are a cause for concern. The advantages they pose for the host country in terms of employment, tax revenue, and wealth concentration are appealing, but they come with a price: the inequalities they harbor. This relates to the trickle-down theory, which is currently questioned as it presumes that the rich spend on investment goods rather than status or imports, and that such spending eventually benefits the broader economy through economies of scale.
Financial Market Mechanics
A financial market requires a capital surplus ready to be lent, a party needing financing, and an intermediary. Banks and financial services exist to assist the industry, not to replace it or turn it into a secondary industry.
The Role of London
London remains a premier financial hub due to its time zone and the English language. Its dominance began in the 18th century following the Industrial Revolution and the Napoleonic Wars. The English economy shifted from diminishing to consistent returns, importing agricultural resources and exporting industrial goods, supported by commercial hegemony and the expansion of the British Empire.
Corporate Restructuring and Liberalization
Liberalization is a key driver for mergers and acquisitions (M&A), creating opportunities that were previously restricted by regulation. Successful operations often involve the buyer “cleaning out” the target by eliminating unprofitable branches and redundant employees. Conversely, a lack of liquidity, funding, or a stock market decline effectively halts M&A activity.
Government Control
Governments often seek to control companies for geopolitical influence. Factors include the number of national workers, domestic sales, capital ownership, and the nationality of administrators and managers.
Investment Banking Evolution
In the USA, investment banking (IB) emerged to fund railroads, acting as intermediaries between companies and investors. The 1934 Glass-Steagall Act mandated a separation between commercial banking and IB operations to ring-fence risks. The 1999 Gramm-Leach-Bliley Act repealed this, allowing commercial banks to re-enter investment banking. This expansion, coupled with the Commodity Futures Modernization Act, contributed to the financial crisis. Post-crisis, the Volcker Rule and Dodd-Frank Act were introduced to restrict proprietary trading and reduce systemic risk.
Corporate Valuation Methods
Equity Methods
- Net Asset Method: Uses historical accounting values.
- Adjusted Net Asset Method: Updates assets to market value, less debt.
- Substantial Value Method: Present market value of goods used in operations, excluding funding sources.
- Liquidation Value Method: Based on disposal options; represents the minimum value.
Multiples Valuation
This method compares share prices with financial data like net profit or earnings per share (EPS). The P/E ratio is a common tool, though it has disadvantages: it requires the company to be profitable, is susceptible to creative accounting, and can be misleading due to volatility or different accounting standards.
Discounted Cash Flow (DCF)
This is the most accurate method for valuing a going concern. It calculates the present value of future cash flows discounted at the Weighted Average Cost of Capital (WACC). The formula for WACC is: KO = Kd(D/V) + Kp(P/V) + Ka(A/V).
Corporate Restructuring Operations
- Divestiture (Sell-off): Selling a subsidiary or division to a third party to provide financial stability.
- Spin-off: Distributing subsidiary shares to parent company shareholders.
- Equity Carve-out: Listing a portion of a subsidiary on the stock market without losing control.
Sovereign Wealth Funds (SWF)
SWFs are state-owned investments in foreign assets. Types include:
- Export-funded: Based on low wages and currency policies (e.g., China).
- Revenue-funded: Based on oil and gas (e.g., Norway, Saudi Arabia).
- Currency-retention: Based on aggressive currency policies (e.g., Singapore).
- Debt-funded: Used for industrial restructuring (e.g., France, Italy).
Takeover Bids (TOB)
A TOB occurs when a company attempts to acquire control of another. Regulations in Spain mandate a total TOB for 100% of shares if an investor acquires 30% or more of voting rights. The process is governed by principles of transparency, equal treatment, and a duty of passivity for the target company’s board.
Initial Public Offerings (IPO)
An IPO involves placing securities into circulation and listing them on the stock market. It differs from a Public Offering for Subscription (POS), where new shares are issued to raise capital. Key stakeholders include retail and institutional investors. Managing entities may use a greenshoe option to stabilize the share price post-IPO.