Investment Banking Series
Post 2: Deal from Sourcing to Completion
1. How hard can it be? Very
How hard is it to close a deal in investment banking? Very hard. It is extremely time-consuming and effort-intensive process. However, I believe that at least a large portion of that effort comes from sheer inefficiency and stunning arrogance of the management, but later on that. Let's concentrate on the workflow for now.2. Typical workflow
The order below is not a fixed one, but rather a guidance to what it may look like. The tasks will change from product to product, and from deal to deal, but this should give you a good idea of the process (and help me remember in the future).Sourcing
A deal may be sourced from a newspaper article or a bold idea, but most commonly it comes from the corporate clients themselves. This is where the coverage bankers' ability to consume alcohol and entertain clients pays off, because they are often able to identify a business opportunity much earlier than it is reported to the broad public. Theoretically, coverage bankers should also be watching the capital structure of their clients and see if the capital structure changes may trigger a capital raising to restore it to the levels defined by that client's financial strategy, but I did not observe them doing so in reality, at least at my firm.Internal Discussions
These can go for ages without arriving at any conclusion. You need to persuade everyone, almost including the old janitor ladies who come to clean up every day, and the nature of the questions you may get has often little to do with business. In my firm the discussion topic often drifted to ridiculing folks in the London office with whom we worked on cross-border deals (to my knowledge they paid us back in kind), demands for unrealistic level of detail and attempts to quietly stifle the idea to get the workload off one's shoulders. The only ideas that were quick to get support were the ones bluntly pushed by the management, or the ones that followed a well-established business process. Both types tended to receive too little scrutiny, and therefore caused a lot of problems later on, when the deal was nearing the execution stage.There were, however, rare cases when the ideas proposed by the team members got adequate attention and reasonable doubt, and gained momentum in so doing.Putting Together A Pitch Book
This is what investor bankers do, for most of the time. I will dedicate a whole post to the nuts and bolts of a pitch book, but to put it shortly, a pitch book is a combination of the market analysis, the bank's credentials in the particular product, claims of being the right bank for the client and a large amount of statistical information and analysis. A basic product introduction pitch book will be fairly standard, and the banker will only need to update the statistics and graphs, slightly change the wording, and put the client's name in bold on the cover page. The more comprehensive internal education materials will cover a broad range of subjects from the client's introduction to explanation of the client's domicile financial regulation and particular technical issues to consider. Of about the same volume, the Lead Arranger proposals will appeal to the client by trying to persuade him/her that the bank understands their business well, by describing the technicalities of the placement and by putting every award and league table available in the end of the book.The hardest and the thickest pitch books are the Global Coordinator proposals. They will include the distribution and allocation in the major markets, in depth analysis of client's business, the equity story (if necessary, slightly different for every investor segment), the syndication proposal, the valuation and much, much more.
Expect the document to be rewritten over and over again by different people without any consultation with each other, and to be blamed for any blunders they put into it in the process.
Making Presentation to the Client
This is the job done by the coverage bankers and the senior management. The senior management usually has little to no idea about the proposal's background and technicalities, so internal documentation is meticulously and painfully put together and presented to them before the client meeting. A big gang will be normally assembled for the client presentation to show the bank's commitment to the deal, and to help the senior manager out, when he finds himself lost in the technicalities.Interestingly, the presentations in investment banking are amazingly dull (pun intended). They are never done on screen, always with the pitch book only, meticulously covering each slide - tribute to the technologically illiterate senior managers, I suppose.
Addressing Client's Questions
Typically, clients will have many questions after the presentation. Some are asked because they really did not understand some part of it, or want some additional information, but others just to check how helpful the particular bank is addressing the client's concerns. Considering that most of the data and information that bankers could dig out is usually already in the pitch book, addressing such questions can be a very hard task. The management will typically be very reluctant to pay for any information (and good a research paper that has the answers can easily go $500-1000), so bankers spend days (and nights) browsing Internet, digging into Bloomberg and Thomson Financial databases, or reading the Research reports in search for the right piece of data.Due Diligence
Due Diligence (DD) process can take several months, and its original goal is to check if the client meets the requirements for the placement in terms of business sustainability, financial indicators, organization, corporate governance and disclosure. However what it really is, is to advise the client on what changes he should make to meet the requirements. DD is done mostly by the audit firms like KPMG, PWC, E&Y and so on, with participation of the Legal Council, client's Investor Relations officer and CFO and packs of bankers. In my case, we had a weekly or bi-weekly calls with participants half around the globe and up to 8 hours apart. Not a case when you can go home early.Underwriting Committee Review
This review is mandatory, but in my experience is done more to appease the regulators, than to actually go through all the items on the check list. Also, most of the identifiable problems are already known by this time, so it is just management decision whether to give green light despite these problems, or stop the deal because of them. Deals are rarely stopped.Also, the timing of the Review is somewhat tricky. Should it be called when all the details of the deal are clear, but little or nothing in the structure can be changed, or when there is still some unclarity about the terms, and much can be done to tune them? Not so easy to decide when you have so many counter parties to deal with.
Internal Education
This part is done mostly for the Sales, who will be selling the product to investors. In my case a large portion of the offerings targeted retail investors, and we had to tackle their utter ignorance with regards to anything that lies outside the Japanese borders, starting with country locations. The documents prepared at this stage will also be used later on, if someone needs to get a good understanding of the deal he was not in charge of.Deal Structuring and Syndication
Deal structuring is about dividing the offering into portions (called tranches) to achieve the best penetration among the investors. Different regulation for retail and institutional investors and differences between countries may make it difficult to place securities in one bunch, hence it needs to be adjusted.As for syndication, it often happens so that a bank feels its client base is not sufficient to deliver the full demand for the client's offering. This is when the tricky business of syndication starts. Other banks are contacted and offered to take part in the offering, but with lower status then the bank offering the participation (its status is usually Lead Arranger or Global Coordinator). Banks with lower status have much less discretion with regards to how they place securities and control the allocation, so it is not always easy to come to a mutually satisfactory solution. But many banks join in eventually, because it is easier to just place securities then to do all the job from pitching client to the allocation.
Roadshow
When the investor base is defined and offering arrangement is gathering steam, it is time to do the premarketing. The client's management is taught in much detail what they should say to make the offering look like a good investment. They go on a trip, often around the world, and speak to the investors (usually institutionals) in the countries where they plan to offer their securities. This process is known as a Roadshow.Valuation
At this stage, bankers build financial models and determine the price range that will be incorporated into the offering prospectus. The idea here is to calculate the number which market analysts and investors would agree to. The valuation is both science, art and guesswork, and I will get back to this topic in later posts.Regulatory Filings
These vary widely depending on the nature of the product and on whether it is a public or private placement. Public placements require documentation up to several hundred pages long, especially if the securities are filed for listing. There is usually a dedicated department or at least a team in the bank called Documentation that deals with this task. The timing of filing is strictly defined under the financial regulations, and the bankers in Documentation do not get much sleep (if any) for several weeks before the offering.Subscription and Book Building
The most widely used way to offer securities in the public market is now Book Building. It determines the price by accepting orders from investors and calculating the number of securities investors are willing to buy and the price they are willing to pay for them.Allocation
Allocation is determined by the Book Builder, and in theory is a pro rata allocation to every investor at the determined offering price. However, in the complicated large-scale deals, there may be allocations to strategic investors, different pricing for domestic retail investors (when a state company is privatized) and other complications. On top of that, in Japan retail investors have a right to cancel their orders at this stage, which can virtually ruin the deal, because the trading in securities may start earlier overseas than in Japan, and if the price goes lower then the offering price, investors will refuse to buy them (this has actually happened before).(Finally!) Receiving the Fees
After the primary offering (and any following lock-up period) is over and securities are traded in the secondary market, the banks finally receive their fees from the client, becoming the base for the fat bonuses of senior management, who rarely play any significant role in the offering. And what about the bankers who originated and executed the deal? They get another assignment and start preparing new pitch books. The infinite loop goes on.3. Lessons
I've heard that in companies like Goldman Sachs or Lehman Brothers (R.I.P.), the situation is different, but at my firm a lot was determined by custom rather than by sound logic and reasoning. So, the key to survival for a banker at the bottom of the fat banking hierarchy during the process above lies in my opinion, in adhering to the following set of rules:This concludes my second post on investment banking.
- a. Know how to deal with difficult people. There will be a lot of them at your bank.
- b. Know the client well. If, for instance, you are thrown in a proposal for a transport company, learn everything you can about it, including what models of trains and buses they use, how many people they transport daily and how are their fares determined.
- c. Cover your back. Many people, including most likely your superiors, will use every chance to mock and ridicule you if you fail to answer any of their questions, so be prepared.
- d. Get to know the people in other departments, who you would work with on a deal. Being able to call a friend directly, rather than going through his boss can save you hours of bureaucratic meddling.
Links to other posts in the investment banking series:
Post 1: Series Introduction
Post 3: Pitch Books
Post 4: Valuation, Part 1
Post 5: Valuation, Part 2
Post 6: Equity Story
Post 7: Roadshows
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