Dear Analysts, Associates and VP in the house,

I need you all to kindly debate and counter any answers given to the questions below. Thanks. Please let the answers start coming in.

Question 1 - A client of yours owns his own business 100% outright. It is worth £500M and he/she would like to get some liquidity out of his company, but still wants to continue working. How do you advise your client to get the maximum valuation, while still retaining some ownership?

Question 2 - A public company is currently trading at a 52-week low. The company's current quarterly reporting is on schedule with analyst's and management's predictions. The management team is looking to raise money to fund a project, which they believe will double the company's EBITDA. What options do you advise the company to pursue in order to raise the necessary capital?

Question 3 - Your client has a company, which manufactures and sells propellers and is preparing to sell the entire company. The company is comprised of three divisions: boat, air, and windmill propellers. The boat and air divisions comprise 80% of the company, while the windmill division makes up only 20%. The boat and air divisions are losing money, while the windmill division is making money, so the net effect of the company is to break even. What do you advise your client to do in order to help them sell their company at the best price (ie. best valuation)?

I fail to agree that these questions are above the superior analytical abilities of our smart analysts, associates and vps on this forum,

Let the heated debate start, ,,,,

Why don't use answer you Qs by yourself, and we can take it from there,

Hi,

Some mates are preparing for an AC(assessment day). I am trying to help them get the best answers. I have told them what I know about raising capital through debt and equity. I believe there is more to be said. Unfortunately, my knowledge is not yet robust O.

Hello,
This name looks familiar? I think we have met on a different thread on this domain (can’t really remember which)

Anyway, the questions you have put forward, are quite ambiguous  because, it will be difficult to give a well balanced investment opinion with the  information provided herein.( No projections or financials et.al)

In this regard, I will assume that the intended outcome is just to have a general understanding of the topic at hand and how theory can be applied to practice. 


Before I present my own take on the topic, there are some certain assumptions I will like to put forward-

PECKING ORDER THEORY-This is used the explain the preference for a particular type of capital structure used by the firm.The theory states states that companies prioritize their sources of financing (from internal financing to equity) according to the Principle of least effort, or of least resistance, preferring to raise equity as a financing means of last resort. Hence, internal funds are used first, and when that is depleted, debt is issued, and when it is not sensible to issue any more debt, equity is issued.

Question One- This is plain simple. Tell the owner to issue and include some debt in the capital structure of the firm. Since the owner still wants to retain some form  of ownership, it is advised that the debt to equity ratio (the debt-to-equity ratio (D/E) is a financial ratio indicating the relative proportion of shareholders' equity and debt used to finance a company's assets) should be more of equity than debt so that the owner can still have a say in the day to day operations of the business. There is no generally accepted range for the debt to equity ratio but since the owners want to remain at the ‘helm of affairs’ whilst having liquidity, I would suggest a maximum range of not more than of 49 to 51(i.e. 49% debt and 51% equity) This is based on your assertion that  the firm is solely owned. It could be 30 to 70,40 to 60 but should not exceed the  limit set above.

However, raising debt can also have it own demerits. This is because, debt holders are entitled to constant interest payments on the debt originated via semi or annual coupon payments but  debt holders, to a large extent do not influence or have a say in the daily operations of the business. Also if the debt is a convertible debt(can be converted to equity) which is usually for high risk transactions or for firms facing financial distress, they could appoint a member to sit on the board of the company in question to act as a check.


Question Two-Personally, I would ask probe further in this case.
What are the management predictions/projections? Is it, likely to exceed that of the previous financial year? What kind of project do they need funding for , what is the investment horizon or time frame for the project to be completed, what are the estimated future cash flows for the project in question?

Anyway the firm needs to identify that source of funding according to the  principle of least effort mentioned above. Since the company is trading at a 52 week low( a market indicator used to measure the trading patterns of publicly quoted and actively traded companies on the stock exchange for a period usually one year i.e 52 weeks).

As the stock is trading at a 52 week low, this implies that it’s market value is below its intrinsic value( i.e discounted price) and perhaps raising money from the equity market will not be the best for them at the moment. This is because they will be giving away their stock away at a low price using the existing market price as a base for setting the offer price for the  proposed seasoned offering.


Question Three- There some vital points to be raised here.
Does your client intend to sell the company as a holding entity or sell in parts through asset stripping? Asset stripping is the process of buying an undervalued company with the intent to sell off its assets for a profit. The individual assets of the company, such as its equipment and property, may be more valuable than the company as a whole due to such factors as poor management or poor economic conditions.

For example, imagine that a company has three distinct businesses: A, B and C. If the value of the company is currently 100 million but another company believes that it can sell each of its three businesses to other companies for 50 million each, an asset stripping opportunity exists. The purchasing company will then purchase the three-business company for 100 million and sell each company off, potentially making 50 million.(By buying the comapny as a whole for 100 million and selling them in parts for 50 million each!)

Personally, I would sell off the boat and air division since there not turning in a profit and invest in the windmill propellers division. This will help increase the appraisal that the firm will get during the  valuation process  for the final sell –off and also increase profit margins at the end of the day.

P.S-Please,don’t mind the typos in my response and I hope this helps or at least gives you some form of guidance? Yes, I remember now, you wanted to know more about career opportunities in Private Equity/Venture Capital on a thread about one MD ‘cursing’ non performers in his bank.

what about ED's like us

There is no generally accepted range for the debt to equity ratio but since the owners want to remain at the ‘helm of affairs’ whilst having liquidity, I would suggest a maximum range of not more than of 49 to 51(i.e. 49% debt and 51% equity) This is based on your assertion that the firm is solely owned. It could be 30 to 70,40 to 60 but should not exceed the limit set above.

Wrong.
There's an optimum position on the U curve shaped Weighted Average Cost of Capital that defines a balanced mix of equity and debt. Read up on Modigliani-Miller Theorem.

@ OP.

Question 1 - A client of yours owns his own business 100% outright. It is worth £500M and he/she would like to get some liquidity out of his company, but still wants to continue working. How do you advise your client to get the maximum valuation, while still retaining some ownership

Private Equity is all your client needs. Think of Facebook Inc as an appropriate case study. And i think you've used the term "valuation" wrongly. Getting a valuation on your business would not make you lose ownership of your business, it simply gives you an estimate of what your business is worth today in terms of future possible cashflows.

Question 2 - A public company is currently trading at a 52-week low. The company's current quarterly reporting is on schedule with analyst's and management's predictions. The management team is looking to raise money to fund a project, which they believe will double the company's EBITDA. What options do you advise the company to pursue in order to raise the necessary capital?

There are several reasons why a company will trade at a 52 week low, for one, it might just be unnecessary market sentiments. That said, if the company is looking to raise capital, debt markets might be the way to go, given that all over the world, interest rates are testing the lowest levels ever seen and might remain so for a long long time to come.

Question 3 - Your client has a company, which manufactures and sells propellers and is preparing to sell the entire company. The company is comprised of three divisions: boat, air, and windmill propellers. The boat and air divisions comprise 80% of the company, while the windmill division makes up only 20%. The boat and air divisions are losing money, while the windmill division is making money, so the net effect of the company is to break even. What do you advise your client to do in order to help them sell their company at the best price (ie. best valuation)?

What do you mean by losing money? are they making losses or is it the case that they aren't making profits? they are both two different things. Either ways, the best valuation for you company will be worth your company is worth, no more, no less. If you are willing to dispose it, you can sell it off in bits as a poster suggested above, but you must remember that this will generate a liquidity problem and you might be forced to sell them for a very low price than selling the company as a whole.

Certain things don't sell like Akara in the market, you will have to wait for months and in some cases years before you find buyers. Who will be willing to buy an air propeller from you in the next few weeks for the amount that it is actually worth? answer? Noone!, well, of course with the exception that you are lucky enough to find people that are desperately in need for an air propeller which only ever happens one in a million cases.

So what will i do? Create a spin-off and dump the shares of both companies in the hands of existing shareholders. You can find out how spin offs and carve outs work and google.

bookface:

Wrong.
There's an optimum position on the U curve shaped Weighted Average Cost of Capital that defines a balanced mix of equity and debt.  Read up on Modigliani-Miller Theorem.

@ OP.
Private Equity is all your client needs.  Think of Facebook Inc as an appropriate case study.  And i think you've used the term "valuation" wrongly.  Getting a valuation on your business would not make you lose ownership of your business, it simply gives you an estimate of what your business is worth today in terms of future possible cashflows.


There are several reasons why a company will trade at a 52 week low, for one, it might just be unnecessary market sentiments.  That said, if the company is looking to raise capital, debt markets might be the way to go, given that all over the world, interest rates are testing the lowest levels ever seen and might remain so for a long long time to come.

What do you mean by losing money?  are they making losses or is it the case that they aren't making profits?  they are both two different things.  Either ways, the best valuation for you company will be worth your company is worth, no more, no less.  If you are willing to dispose it, you can sell it off in bits as a poster suggested above, but you must remember that this will generate a liquidity problem and you might be forced to sell them for a very low price than selling the company as a whole.

Certain things don't sell like Akara in the market, you will have to wait for months and in some cases years before you find buyers. Who will be willing to buy an air propeller from you in the next few weeks for the amount that it is actually worth?  answer?  Noone!, well, of course with the exception that you are lucky enough to find people that are desperately in need for an air propeller which only ever happens one in a million cases.   

So what will i do?  Create a spin-off and dump the shares of both companies in the hands of existing shareholders.  You can find out how spin offs and carve outs work and google.

Well said. M and M theory relaxed a lot of assumptions some of which I will outline below-

[list]
[li]The theory assumes that the market  is perfect (in reality, there is no such thing as a perfect market)
It also assumes that there no transaction or bankruptcy costs; firms and individuals can borrow at the same interest rate; no taxes; and investment decisions aren't affected by financing decisions.
There is no asymmetry of information( information asymmetry deals with the study of decisions in transactions where one party has more or better information than the other this is the typical case with the Nigerian capital market , that is why a 'selected minority' always take the majority  of  investing public for a 'joy ride' over and over again!)
[/li]
[li][/li]
[/list]

Of course you will agree with me that all these don't apply in reality. Also there are other propositions put forward by M and M himself like MM II(including taxes), critique by Jensen and Meckling [i]et a[/i]l. So in the real world, there is no clearly defined optimal capital structure for a firm. Even in the graph that you have mentioned ,what is suggested is a range and a stop point. In the real world, the optimal capital structure is determined by the level of expansionary activities or projects funded by the firm. I have only suggested a solution based on the question

Secondly, 'private equity' used here is a generic term because it consist several several asset classes (one common feature with all is that investments are in companies that are not publicly traded on the stock exchange, like the Facebook example cited) These asset classes include but not limited to the following

[list]
[li]Leveraged buyouts- involves the process whereby business assets of a firm is acquired from the current owners typically with the use of financial leverage(also known a DEBT)


Venture capital- broad subcategory of private equity that refers to equity investments made, typically in less mature companies, for the launch, early development, or expansion of a business( used by Facebook and funding provided by a broad range of institutional investors including Goldman Sachs, Nomura holdings (PE arm of Nomura International a leading Japanese bank, Empirica and Black Rock LLP- two hedge fund managers with billions AUM-assets under management

Growth capital- equity investments, most often minority investments, in relatively mature companies that are looking for capital to expand or restructure operations, enter new markets or finance a major acquisition without a change of control of the business

Distressed investments-  can also be known as special situations investments and is  is a broad category referring to investments in equity or debt securities of financially stressed companies.

Mezzanine capital-This form of financing is often used by private equity investors to reduce the amount of equity capital required to finance a leveraged buyout or major expansion.
[/li]
[li][/li]
[/list]
I would be happy if you could tell me which kind of 'private equity' you think would be appropriate to use whilst putting the question in context. Remember the the original poster said that the owner wants  'liquidity' (  firm is not a growth or emerging firm, is not going bankrupt  nor expanding and still wants to maintain control)



For question two, we are on the same page because I have suggested that raising money from the equity market was not the best since the capital required is to fund a project which I presuppose would have a life span. You say that interest rates are quite low now? Are you sure?. Even with the ever occurring debt crisis in the Eurozone (in the  P.I.G.S countries and the recent downgrading of the US credit rating by Standard and Poor? See link below to back up my claim


I agree to an extent  with you answer to question three, for the following reasons creating a 'spin off' will help the firm divest the part of the business that is not making profit (only enriches a few people especially those at the 'top management'), streamline their core operations and concentrate on the 20% that makes 80 % of the profit but also bear in mind that this process is very cumbersome, time consuming and involves money as well.



However, I seriously doubt if a 'carve out' can be applied in this context because in a 'carve out' the firm only sells a minority stake (usually 20% or less) in a subsidiary for an IPO or rights offering. Going by the question, poster asserts the the boat and air division make up about 80% of the business and that the the company is to be sold off at the best price.

P.S I have attached a link here for a PDF document. It is an article  on a M and M and other propositions put forward on the capital structure of the  firm. They have also tested these assumptions  on selected industries and come up with some interesting conclusions and a link to show the recent global bond rates, you can also get up to date info on the rates from Bloomberg or Thomson Reuters website, HAPPY READING


http://markets.ft.com/research/Markets/Bonds

http://www.studyfinance.com/jfsd/pdffiles/v7n3/hatfield.pdf

Well said. M and M theory relaxed a lot of assumptions some of which I will outline below-

The theory assumes that the market is perfect (in reality, there is no such thing as a perfect market)
It also assumes that there no transaction or bankruptcy costs; firms and individuals can borrow at the same interest rate; no taxes; and investment decisions aren't affected by financing decisions.
There is no asymmetry of information( information asymmetry deals with the study of decisions in transactions where one party has more or better information than the other this is the typical case with the Nigerian capital market , that is why a 'selected minority' always take the majority of investing public for a 'joy ride' over and over again!)
[/li]

Of course you will agree with me that all these don't apply in reality. Also there are other propositions put for for M and M himself like MM II(including taxes), critique by Jensen and Meckling et al. So in the real world, there is no clearly defined optimal capital structure for a firm. Even in the graph that you have mentioned ,what is suggested is a range and a atop point. In the real world, the optimal capital structure is determined by the level of expansionary activities or projects funded by the firm. I have only suggested a solution based on the question

Assumptions of MM theory or not, all companies know that there's always an optimal position for equity and debt in a capital structure. Critiquing assumptions has never made them less viable. for instance, the assumption of normality of asset returns is one that has been made for centuries, and even though it's very wrong and has been criticized over and over, it remains the principal tool for which multi billion pounds deal are made.

Saying there's no generally accepted range for the debt equity ratio mix is a totally wrong concept and although debt is cheaper than equity, there's a point where an extra increase in debt will do more harm than good in your overall capital structure. And no, i won't have to go trawling through academic journals to buttress this point, I'm simply telling you what obtains in the real world.

Secondly, 'private equity' used here is a generic term because it consist several several asset classes (one common feature with all is that investments are in companies that are not publicly traded on the stock exchange, like the Facebook example cited) These asset classes include but not limited to the following

It's called Venture Capital. All you do is simply to approach an Investment bank who values your business and sells a certain level stake in your business to some of their rich friends, your firm does not have to be a growth firm or a rapidly expanding one. Stop reading all that stuff you see in your textbooks and start studying what actually goes on out there.

If Mr XYZ approaches Warren Buffet with an offer to sell 10% of his business, it's called a "Private Equity" and the type of private equity could be classed as "Venture Capital".

For question two, we are on the same page because I have suggested that raising money from the equity market was not the best since the capital required is to fund a project which I presuppose would have a life span. You say that interest rates are quite low now? Are you sure?. Even with the ever occurring debt crisis in the Eurozone (in the P.I.G.S countries and the recent downgrading of the US credit rating by Standard and Poor? See link below to back up my claim

Are you in the financial industry at all? pardon my indignant statement, but I'm not quite sure I'm having this conversation with someone that has an understanding of events in the financial industry.
Of course Interest rates are at the lowest, in Japan its 0.00, in US, 0.25, in UK, 0.50. Eurozone which went ahead to increase base interest rates in the first quarter are quite unsure what to do now in the case of rising bond yields that meant that staggering companies will have to borrow at higher interest rates.
We are in a recession, and there are prospects of QE3 coming up anytime soon, which means companies will even have more free cash at their disposal.

However, I seriously doubt if a 'carve out' can be applied in this context because in a 'carve out' the firm only sells a minority stake (usually 20% or less) in a subsidiary for an IPO or rights offering. Going by the question, poster asserts the the boat and air division make up about 80% of the business and that the the company is to be sold off at the best price.

I suggested a spin off and not a carve out, i only mentioned a carve out for OP to read up on.


PS. sorry if i have been unduly rude in my remarks, they were probably necessary.

deenee and bookface, Thanks, I just wanted diverse opinions, I can see that you guys are justifying the 6-digit foreign currency you earn per annum, The responses have been exemplary! I will sit down, read them up and finally send them to the mates who preparing for the IB interview,

@deenee, is it really that possible to intern free of charge at Goldman? Men, I don't mind O, But I am MSc not MBA, How do I romance GS HR?


PS: I am in Western Europe, not the US.

candylips:

what about ED's like us

Oga sir, na deals una dey porshu now , Belle don fat, cheek don swell,


Alright, your contributions will be valued. Abeg let them start coming in--

tanimola22:

deenee and bookface, Thanks, I just wanted diverse opinions, I can see that you guys are justifying the 6-digit foreign currency you earn per annum, The responses have been exemplary! I will sit down, read them up and finally send them to the mates who preparing for the IB interview,

@deenee, is it really that possible to intern free of charge at Goldman? Men, I don't mind O, But I am MSc not MBA, How do I romance GS HR?


PS: I am in Western Europe, not the US.

Hello, I just spoke to a friend in GS and she said that that recruitment for 2012 intake will start in September. I am not sure if this is applicable to other regions (EMEA-Europe ,Middle East and Africa and Asia) because this information is for the Americas only-including Canada. Also you would need to have a work permit for your application to be considered.

If you applying for an analyst position, then your M.Sc qualification should suffice. Best of Luck!

deenee:



Hello, I just spoke to a friend in GS and she said that that recruitment for 2012 intake will start in September. I am not sure if this is applicable to other regions (EMEA-Europe ,Middle East and Africa and Asia) because this information is for the Americas only-including Canada. Also you would need to have a work permit for your application to be considered.

If you applying for an analyst position, then your M.Sc qualification should suffice. Best of Luck!

Thanks deenee,

I am looking at the EMEA zone. I recently sent an email to one chick HR personnel at GS London office. I am hopeful,

^^

your best bet is moving to London!

.