Introduction to Corporate

Corporate Finance InstituteⓇ LearningClick to edit objectives Master title style

By the end of this course, you will be able to:

Discuss the main capital Explain the process of Compare financing with activities and , financing and explain techniques and key considerations for the optimal the deal

Outline the capital raising Explore various career paths process in

CorporateCorporate Finance Finance Institute InstituteⓇ Ⓡ Introduction

Corporate Finance InstituteⓇ Corporate finance overview

The ultimate purpose of corporate finance is to maximize the value of a business through planning and implementing management resources while balancing risk and profitability.

Capital Capital Financing Dividends & Return of Capital • Decide what projects / • Determine how to fund businesses to invest in capital investments • Decide how and when • Earn the highest possible • Optimize the firm’s to return capital to risk-adjusted return capital structure

Corporate Finance InstituteⓇ Players in corporate finance – primary market

Public Bonds or shares $ firms

“” $ Contacts Contacts “” Fund Manager $

Corporations Investment Institutions Investors

Capital

Corporate Finance InstituteⓇ Players in corporate finance – secondary market

Wants to sell Wants to buy exchange Fund Manager Fund Manager / OTC

Investment Investment bank Sales, trading Sales, trading and research and research

Corporate Finance InstituteⓇ Types of participants

$

Retail Institutional Public Private Investors

• High net worth • Mutual funds • Traded on stock • Owned and individuals • Pension funds exchanges traded by a few private investors • firms • firms • Seed / angel investors

Corporate Finance InstituteⓇ Types of transactions

Initial public Follow-on Private offering (IPO) offering placement

Mergers & Divestiture acquisitions (LBO) (M&A)

Corporate Finance InstituteⓇ Capital Investments

Corporate Finance InstituteⓇ What is a capital investment?

Any investment for which the economic benefit is greater than one year.

Opening a new Entering a new Acquiring another Research and factory market business development of new products

Corporate Finance InstituteⓇ Capital investment

Capital investments will increase the assets of a company.

Debt

Assets

Equity

Corporate Finance InstituteⓇ Techniques for valuing an investment

Whether such investments are worthwhile depends on the approach that the company uses to evaluate them. A company may value the projects based on:

Net (NPV): The value of all future flows (positive and negative) over the entire life of an investment discounted to the present.

Internal (IRR): The expected compound annual rate of return that will be earned on a project or investment.

Corporate Finance InstituteⓇ (NPV)

Future Cash Flows $100 $100 $100 $100 $100 $100 $100 $100 … 2019 2020 2021 2022 2023 2024 2025 2026 …

Corporate Finance InstituteⓇ Net Present Value (NPV)

Future Cash Flows $100 $100 $100 $100 $100 $100 $100 $100 …

2019 2020 2021 2022 2023 2024 2025 2026 …

Forecast Period

Corporate Finance InstituteⓇ Net Present Value (NPV)

Future Cash Flows $100 $100 $100 $100 $100 $1,200

2019 2020 2021 2022 2023 2024 - onwards () Forecast Period

Corporate Finance InstituteⓇ Net Present Value (NPV)

Future Value $100 $100 $100 $100 $100 $1,200 1 1 1 1 1 x 1 x x x x x 1.10 1.102 1.103 1.104 1.105 1.105

745 Net Present Present Value 91 + 83 + 75 + 68 + + = Value (NPV) 1 62 = FV x (1+ i)n = $1,124 2019 2020 2021 2022 2023 2024 - onwards (terminal value) Discount Rate Forecast Period () i = 10%

Corporate Finance InstituteⓇ Terminal value

Terminal Value: Value of beyond the forecast period

Growing perpetuity formula

Free cash flow x (1 + growth) Terminal value = Cost of capital - growth

Exit multiple formula

Financial Metric (i.e. Earnings, Terminal value = EBITDA, Revenue) x Multiple

Corporate Finance InstituteⓇ Terminal value

Terminal value $100 x (1 + 1.54%) $1,200 Perpetual growth = 10.00% - 1.54% =

Terminal value 12 x $100 $1,200 Exit multiple = =

Corporate Finance InstituteⓇ Unlocking the drivers of value

• Business strategy • Revenue • Cost structure • Organic growth? • Asset utilization • What’s sustainable?

Free cash flow x (1 + growth) Terminal value = Cost of capital - growth

• Risk • Organic growth? • Current capital • What’s sustainable? structure • Macro factors

Corporate Finance InstituteⓇ vs. equity value

Enterprise value is the value of the entire business. Equity value is the value shareholders would receive if the company is sold.

Market value of net debt

=Equity Value + Debt – Cash Enterprise =NPV of the business value Market value of equity =Share Price x Outstanding Shares (market =NPV of the business – Debt + Cash capitalization)

Corporate Finance InstituteⓇ (IRR)

Internal Rate of Return IRR = 22%

22% IRR is economically equivalent to earning a 22% compound annual growth rate.

Corporate Finance InstituteⓇ Mergers and Acquisitions (M&A)

Mergers and acquisitions is the process of companies buying, selling, or combining businesses.

Benefits: Potential drawbacks:

• Cost savings • Overpaying • Revenue enhancements • Large expenses associated • Increase market share with the investment • Enhance financial resources • Negative reaction to the merger or acquisition

Corporate Finance InstituteⓇ 10 step acquisition process

10

9 Integration

8 Financing

7 Purchase & Sales Contract 6 Due Diligence 5 Negotiation

4 Data & Detailed Valuation 3 Approaching Targets 2 Searching for Target 1 Acquisition Criteria Acquisition Strategy

Corporate Finance InstituteⓇ Strategic versus financial buyers

Strategic buyers VS Financial buyers

• Operating businesses • Private equity () • Horizontal or vertical expansions • Professional (non-operator) • Involves identifying and delivering • Leverage for maximum equity operating synergies returns

Corporate Finance InstituteⓇ Rival bidders

The vast majority of acquisitions are competitive or potentially competitive.

• Companies normally have to offer more than rival bidders • To pay more than rival bidders, the buyer may: • Be able to “do more” with the acquisition • Accept a lower expected return • Have a different view or forecast for the future

Corporate Finance InstituteⓇ Acquisition valuation process

Strategic Buyer Scenario:

• Sales growth 1. Value the target • EBIT margin as stand-alone • Operating • Working capital requirements Enterprise value • Capital expenditures

• Sales (volume & price) • Working capital 2. Value synergies • EBIT margin • Vendor relationships • Product mix • Capital expenditures • Overhead reductions Hard (cost savings) and soft • Efficiencies (revenue enhancements) • Operating tax • Tax efficiency • Tax losses

Corporate Finance InstituteⓇ Best practice acquisition analysis

1 2 3 4 5 6

Soft Transaction synergies costs

Hard Net Value created synergies synergies

Stand-alone Consideration enterprise Stand- (price paid) value alone value

Corporate Finance InstituteⓇ Issues to consider when structuring a deal

Market Environment

Contract Structuring Antitrust law Environment rules

Strategic Competing plan bidders

Accounting Deal Available rules financing Hostile vs Public vs friendly private

Capital structure

Corporate Tax Law

Market conditions

Corporate Finance InstituteⓇ Corporate finance overview

The ultimate purpose of corporate finance is to maximize the value of a business through planning and implementing management resources while balancing risk and profitability.

Capital Investments Capital Financing Dividends & Return of Capital • Decide what projects / • Determine how to fund businesses to invest in capital investments • Decide how and when • Earn the highest • Optimize the firm’s to return capital to possible risk-adjusted capital structure investors return

Corporate Finance InstituteⓇ Capital Financing

Corporate Finance InstituteⓇ What is capital financing?

Any type of funding that is used to finance the purchase of an asset/project (an investment).

Equity Debt

Corporate Finance InstituteⓇ Capital financing

Capital financing will increase the liabilities and/or equity of a company.

Debt Capital Capital investment financing (spending Assets (where the money to money purchase comes from) assets) Equity

Corporate Finance InstituteⓇ Capital financing

Capital financing will increase the liabilities and/or equity of a company.

Capital Debt Capital investment financing (spending Assets (where the money to money purchase comes from) assets) Equity

Corporate Finance InstituteⓇ Capital financing

Capital financing will increase the liabilities and/or equity of a company.

Debt

Capital Capital investment financing (spending Assets (where the money to money purchase Equity comes from) assets)

Corporate Finance InstituteⓇ The business life cycle

LAUNCH GROWTH SHAKE -OUT $ Life cycle extension

Sales

Cash flow

Profit

Time

Corporate Finance InstituteⓇ The corporate funding life-cycle

LAUNCH GROWTH SHAKE MATURITY -OUT Debt funding

Business risk

Stage of the firm life cycle

Corporate Finance InstituteⓇ Capital structure

Capital Structure: the amount of debt and/or equity employed by a firm to fund its operations and finance its assets. In order to optimize the structure, a firm will decide if it needs more debt or equity and can issue whichever it requires.

Low Leverage High Leverage

Corporate Finance InstituteⓇ Optimal capital structure

The equity versus debt decision relies on a large number of factors:

The current economic climate

The business’ existing capital structure

The business’ life cycle stage

Having too much debt may increase the risk of default in repayment.

Depending too heavily on equity may dilute earnings and value for original investors.

Corporate Finance InstituteⓇ Optimal capital structure

Companies are usually looking for the optimal combination of debt and equity to

minimize the cost of capital. Weighted Average Cost of Capital (WACC) Capital of Cost Average Weighted

Debt/Total Capital (Leverage)

Corporate Finance InstituteⓇ Weighted Average Cost of Capital (WACC)

Weighted Average Cost of Capital (WACC) is the proportion of debt and equity a firm has, multiplied by their respective costs.

Cost of Equity: Cost of Debt: The rate of return a The rate of return that a shareholder requires for lender requires given the investing equity into a business risk of the business

The optimal capital structure of a firm is often defined as the proportion of debt and equity that result in the lowest weighted average cost of capital (WACC) for the firm.

Corporate Finance InstituteⓇ WACC formula

Net debt % net debt x Cost of debt = Contribution

Assets Market value % equity x Cost of equity = Contribution of equity Cost of capital

Example

$32bn 14%* x 3.5% = 0.5%

$225bn

$193bn 86%* x 9.0% = 7.7%

8.2%

*Rounded for ease of calculation.

Corporate Finance InstituteⓇ Capital stack

How to optimally finance the capital investments through the business’ equity, debt, or a mix of both?

Senior debt

Subordinated debt

Equity

Corporate Finance InstituteⓇ Types of equity

Senior debt

Subordinated debt

S/holder Higher position; no dividend but pays

Pref.Equity shares Higher liquidation and higher dividend priority (vs Common)

Common shares Last liquidation position and last dividend position

Corporate Finance InstituteⓇ Common shares

Terms Issues

Typically the majority of a • Last level of priority (highest firm’s equity capital: risk) for investors • Proportional share of residual value of the business • Proportional payment of common dividends • Voting rights (or not)

Corporate Finance InstituteⓇ Preferred shares

Terms Issues The ‘norm’ is for private equity Preferred shares are to subscribe for preferred becoming less attractive as:

shares which are: • More costly than Common • Liquidity preference shares • Have a fixed dividend • Even if company has cash, • Anti-dilution rights payment may not be made if lack of distributable reserves.

Corporate Finance InstituteⓇ Shareholder loans

Shareholder loans are a means for private equity houses to invest sufficient equity into a buyout situation, whilst still allowing management a significant equity stake.

Max debt $30m Enterprise value

$50m Shareholder - PIK Equity $16m $20m Private equity $2m

Management $2m

Corporate Finance InstituteⓇ Sources of equity

Private Markets Public Markets

Founders Institutional

Venture Capital

Private Equity

Corporate Finance InstituteⓇ Private equity and venture capital firms

Private equity firms manage funds or pools of capital that invest in companies that represent an opportunity for a high rate of return.

Private equity funds invest for limited time periods. Exit strategies include IPOs, selling to another private equity firm, etc.

Private equity funds are typically split into two categories:

Venture capital funds typically invest in Buyout or LBO funds typically invest in more mature businesses, 1 early stage or expanding businesses that have 2 usually taking a controlling interest and leveraging the equity limited access to other forms of financing. investment with a substantial amount of external debt. Buyout funds tend to be significantly larger than venture capital funds. • • Blackstone • • KKR • Andreessen Horowitz • Carlyle Group

Corporate Finance InstituteⓇ Typical exit routes for private equity

Total Exit Partial Exit

Private Corporate Sale to Strategic Sale to Sponsor Placement

Flotation/IPO

Corporate Finance InstituteⓇ Why use debt

Corporation: (1) to lower the cost of Investor: to increase their equity return capital, and (2) avoid equity dilution

Senior debt

Senior debt Three to five years

Weighted Average Average Weighted Equity Cost of Capital (WACC) Capital ofCost Equity IRR = 28%

Debt/Total Capital (Leverage)

Corporate Finance InstituteⓇ Assessing debt capacity

General measures measures Cash flow measures

• Level of EBITDA • Debt to equity • Total debt / EBITDA • Volatility and hence • Debt to capital • Senior debt / EBITDA stability of EBITDA • Debt to assets • Net debt / EBITDA • Capital expenditures • Etc. • Cash interest cover • Cyclicality • EBITDA-Capex / interest • Risk • Competition

Corporate Finance InstituteⓇ Senior debt overview

Revolver Revolver: Revolving line of facility from a bank

Term loan A Senior debt Term loans: have a fixed schedule where they repay Term loan B or are amortized, and have a final principal repayment. Can be stacked. Term loan C

Subordinated Senior Debt Capacity: debt • Provide 2x to 3x EBITDA

• Require 2x interest coverage

Equity • Typically provided by: commercial banks, credit companies, companies

Corporate Finance InstituteⓇ Types of subordinated debt

Increasing Increasing return

Senior debt

High bonds Increasing dilution Subordinated Mezz warrantless Subordinated debt is used to fill Mezz warranted the funding gap. debt PIK notes

Vendor notes

Equity

Corporate Finance InstituteⓇ How much subordinated debt?

Subordinated debt holders will only supply so much debt.

Total debt / EBITDA ~ 5 to 6 times

xEBITDA / Cash interest ~ 2 times

Equity funding ~ 30% to 35%.

The appropriate financial structure has to be constructed within these constraints.

Corporate Finance InstituteⓇ Credit ratings and high yield debt

Moody’s S&P Fitch DBRS

Aaa AAA AAA AAA Aa1 AA+ AA+ AA (high) Aa2 AA AA AA Investment grade Aa3 AA- AA- AA (low) A1 A+ A+ A (high) • Low risk A2 A A A • Low return A3 A- A- A (low) • Low fees Baa1 BBB+ BBB+ BBB (high) Baa2 BBB BBB BBB Baa3 BBB- BBB- BBB (low)

Ba1 BB+ BB+ BB (high) Ba2 BB BB BB Ba3 BB- BB- BB (low) High yield B1 B+ B+ B (high) • High risk B2 B B B B3 B- B- B (low) • High return Caa1 CCC+ CCC+ CCC (high) • High fees Caa2 CCC CCC CCC Caa3 CCC- CCC- CCC (low) - D D D

Corporate Finance InstituteⓇ Mezzanine debt characteristics

Mezzanine debt: • Non-traded • Subordinated to senior debt • Repaid as a bullet (not amortized) • Combination of cash and accrued interest built into return • Can have equity warrants attached • Debt with warrants, convertible loan stock, convertible preferred shares

Corporate Finance InstituteⓇ Mezzanine returns

Warrants 3% to 10% of post exit value Total Mezzanine Accrued Return interest (IRR 14%

to 20%) return

Contractual Cash pay interest

Corporate Finance InstituteⓇ Mezzanine returns

Senior Debt Warrants IRR <10% 3% to 10% of post exit value Total Mezzanine Subordinated Accrued Return Debt interest Mezzanine (IRR 14% to 20%) investors

return IRR 14-20%

Contractual Cash pay interest Equity IRR 20-30%

Corporate Finance InstituteⓇ Debt repayment profiles

$

Mezzanine finance – high yield debt

Equal Balloon Bullet Bullet amortizing repayment repayment repayment

time

Corporate Finance InstituteⓇ Capital Raising Process

Corporate Finance InstituteⓇ

The process where a bank raises capital for a , or institution from investors in the form of equity or debt securities. Underwriting involves conducting research, , valuation, and marketing and a deal.

Corporate Finance InstituteⓇ Types of underwriting

Types of underwriting commitment:

Firm Commitment Best Efforts The underwriter agrees to buy Underwriter commits to selling the entire issue and assume full as much of the issue as possible financial responsibility for any at the agreed-on offering price, unsold shares. but can return any unsold shares to the issuer without financial responsibility.

Corporate Finance InstituteⓇ Underwriting advisory services

Planning Issue Structure Timing and Demand

• Identify investor themes • Domestic or international • Hot or cold issue market • Investment rationale • focus • Supported by positive news-flow • Financial modeling & valuation • Retail investor focus • Investor appetite • Is IPO the best ? • Offer for sale • Precedents and benchmark • Size of float and lock-up issues • Intermediaries offer offerings • Preliminary view on investor • Introduction • Pricing demand

Corporate Finance InstituteⓇ Underwriting - the process

Institutional Price is Book of Indicative price investor set to demand Allocation range commitment ensure built at firm price clearing

Corporate Finance InstituteⓇ Underwriting - the road show

The roadshow is an opportunity for management to convince investors of the strength of the business cases.

Areas that are critical include:

Management structure, A thorough analysis of governance and quality the industry/sector

Strategy, both tactical Key risks and long-term

Funding requirements and purpose: Cash in versus cash out

Corporate Finance InstituteⓇ Pricing the issue

Key issues in pricing

Price stability

Buoyant after market

Depth of investor base

Corporate Finance InstituteⓇ Pricing the issue

After market price performance Maximizing price

Corporate Finance InstituteⓇ Under-pricing

There are two costs associated with a flotation: • Direct cost / Fees • Indirect cost / Under-pricing

There is a temptation for the advising bank to underprice the issue — why? • Reduces the risk of equity overhang • Ensures after market is buoyant • BUT this fails to make the best possible returns for the current owners and could lead to profit-taking and hence volatility

Corporate Finance InstituteⓇ The IPO pricing process

IPO discount

Full value IPO pricing

Corporate Finance InstituteⓇ The IPO pricing process

IPO discount Indicative maximum 10 to 15% pricing range Indicative minimum Full value IPO pricing

Corporate Finance InstituteⓇ The IPO pricing process

IPO discount Indicative maximum 10 to 15% pricing range Indicative minimum Full value

IPO pricing

Corporate Finance InstituteⓇ The IPO pricing process

IPO discount Indicative maximum 10 to 15% pricing range Indicative minimum Full value IPO pricing You will be pricing the deal based on: • Relative valuation • Intrinsic valuation

Corporate Finance InstituteⓇ Dividends and Return of Capital

Corporate Finance InstituteⓇ Corporate finance overview

The ultimate purpose of corporate finance is to maximize the value of a business through planning and implementing management resources while balancing risk and profitability.

Capital Investments Capital Financing Dividends & Return of Capital • Decide what projects / • Determine how to fund businesses to invest in capital investments • Decide how and when to return capital to investors • Earn the highest possible • Optimize the firm’s capital risk-adjusted return structure

Corporate Finance InstituteⓇ Dividends and return of capital

Corporate managers need to decide to:

Distribute the earnings to shareholders in the form of dividends or share buybacks, OR

Retain the excess earnings for future investments and operational requirements

Corporate Finance InstituteⓇ Internal Rate of Return (IRR)

Internal Rate of Return IRR = 22% (based on cash flows)

Corporate Finance InstituteⓇ WACC

Net debt % net debt x Cost of debt = Contribution

Assets Market value % equity x Cost of equity = Contribution of equity Weighted Average Cost of Capital WACC = 28%

Corporate Finance InstituteⓇ Decision

Internal Rate of Return Cost of Capital = 22% = 28%

Return Capital (Dividend or Buyback)

Corporate Finance InstituteⓇ Retained earnings and excess cash

Balance Sheet

Corporate Finance InstituteⓇ Retained earnings / excess cash decision flowchart

Retained earnings / Cash balance

Rate of return on capital Rate of return on capital investment < WACC investment > WACC

Repurchase Pay cash Reinvest in shares dividends other projects

Corporate Finance InstituteⓇ Dividend vs Share Buyback

Dividend Buyback (Repurchase) • Can be one-time or ongoing • Reduces the number of • Contribute to the “yield” on a shares outstanding stock if ongoing regular • Increases EPS dividends • No impact on shares outstanding or EPS

Corporate Finance InstituteⓇ Corporate finance overview

The ultimate purpose of corporate finance is to maximize the value of a business through planning and implementing management resources while balancing risk and profitability.

Capital Investments Capital Financing Dividends & Return of Capital • Decide what projects / • Determine how to fund businesses to invest in capital investments • Decide how and when to return capital to • Earn the highest possible • Optimize the firm’s investors risk-adjusted return capital structure

Corporate Finance InstituteⓇ Corporate Finance Careers

Corporate Finance InstituteⓇ Career map

Corporate Finance InstituteⓇ Roles in corporate finance

Banks (‘Sell side’) Public Accounting Institutions (‘Buy side’) Corporates

• Client facing / sales • Mix of client or inward • More internally focused • Internally focused component focus • Hire from banks • Hire from banks, accounting • Capital Markets hire from • Hire from schools or from • Hire grad school students firms, institutions and schools schools other accounting firms • Long hours • Hire across all entry points • Retail hires at various • Long / medium hours • Competitive • Hours vary points • Competitive • Quick career progression • Competitiveness varies by • Long hours • Clear career path company • Competitive • Career progression varies • Quick career progression

Corporate Finance InstituteⓇ