Introduction to Investment Banking Modeling, Mergers & Acquisitions & Valuation

We're going to talk about investment banking, modeling and valuation very quickly. I just want to put it on your radar screen. And later on in the course, we'll actually get to do a case study of a model and what project, what the valuation should be for a company when we hopefully work on the IPO of your buddy Tony Shark's Company, Shark Virtual Reality. I hope we're going to get that deal. Please, please don't quit. I want you to stay here. I know he's trying to recruit you, but stay here. Okay. I'll cop you well. Okay. Thank you. Thank you. So when are you model? You're basically predicting the future by building out financial statements. And as I've mentioned before, in this course, we start top down and we drill down after we understand the macro, which we do now. Now we understand investment banking. Then we'll do stock market, more Excel exercises, the buy side, and eventually we'll drill down to modeling and projecting earnings, which is at the bottom of the income statement. So let's now talk a little bit more about the investment bankers role when it comes to modeling and valuation. Okay. So you need to put in a ton of comments. See this here, put the comments in your model because you're going to be working on teams and I'll show you exactly what this means. So let's say that you're forecasting revenue in 2019 or whatever it might be. So right here, say you want to add a comment, you can insert a comment here and say you always put your initials first and the date as well. Let me just move this little dude over here and then you right click and you go to edit comment. So my initials are C-H, right? So you'll type in C H, the date OC. And maybe the person you're talking to, CFO, if it was that person, then you put in your comments here, whatever that might be. And then. If somebody else visits the model and they have another comment to put in, they should use the exact same naming convention, except they should put their. So let's say it's John Snow. Right. And the date and the executive he spoke to for that model update, whatever it is and then just type below that. I think you get the idea and I want to mention that Isabelle is going to do every single type of model and every type of evaluation. It's very important for her to do that. And you always have to cast your net wide if you're a banker. So for an IPO, the analysts have got a model and value companies, assuming that every type of customer is going to look at it, you know, value investors, they like DCF growth investors, they like price or revenue GARP investors, they like both or neither. So you have to do this because the equity sales force has tons of different types of clients. They're going to talk to mutual funds and hedge funds and that sort of thing. So make sure that it's perfect as well because it's going to feed into the S-1 filing eventually and maybe parts of it will go into the sales memo the equity capital markets will use to educate the sales force on the trading floor at the investment banks for an IPO. And a lot of it will go into pitch books as well. So again, cast your net very, very wide. Okay. Now let's talk about mergers and acquisitions. So models are. You can you can always show in a model where M&A discrepancies exist. And again, you never have perfect information, but you can make a lot of assumptions and you have to put models of two separate companies side by side before merging them, because you have to understand where the synergies are or if there's any redundancies. Like if you have one company buying another company and there's, you know, a CFO of both companies, you know that you're going to have to unfortunately get rid of one of those CFOs or reallocate them to a different department. Right. And so, again, you never have perfect information, but you start out by putting the models side by side, and then you basically add the stuff together. And I'll give you an example in a second. It can often be more of an art than than a science. Actually, before we go on, I'm going to go back to my model here. And LinkedIn bought this company called Linda. And we have this model out here is well, let's take a look here. I'm just doing this on the fly right on. Here it is. So they bought Linda, right? And so we are able to add the revenue numbers for Linda or at least as much information as we have. We don't have all the information. We only had Linda on an annual basis back here. Och it, we have it on an annual basis here and I think we have quarterly for some of the numbers here. Just three of them. Okay. So again, it's more of an art than a science. And then what we can do is, of course, you forecast that going forward. We figure that growth is robust initially because Linda is going to be sold through LinkedIn's massive distribution channels globally. And of course, growth will slow over time. And that's all we have from Linda. We don't have that much else, but it's very important to separate Linda from the rest of a model because you want to understand what organic growth is, meaning growth. X Linda Very important. Very important. And that's going to be lumped into the learning and development section going forward. That's what they're going to call it at least. Okay. Let's go back again. Modeling is often more of an art than a science. You'll never have perfect information. Just do the best you can. And it's actually a lot easier and it's fun. Easier than you think. Right? So you got to ask the management team for a gazillion comments on every sell about the model and they'll help you out too. It's their job. You'll sit down with the CFO and the CFO will basically explain every single line item, right? Every line item. And you can comment the heck out of your your your cells here as well. Again, you do right click and go to insert comments. And we talked about that already. And they're there they're there to help you help you with your estimates on the future in terms of what you're modeling and also the past as well. Back to our presentation. Cool. So let's actually do a quick case study on Coca-Cola and a hypothetical investment that they have in Monster. So Coca Cola is obviously sold everywhere in the world. It's one of the most recognizable brands. And then you have monster that's not sold in every country of the world. Let's just assume it's, I don't know, a quarter of the world, roughly speaking. So Coca Cola has got all those executives on the left side. You see in gold the CFO, the CFO, CMO, chief technology officer, chief security officer, CIO, etc., that sort of thing. And you can see on the right hand side in silver here, that monster has similar titles for all of their management team. Okay. And so Coca Cola, actually. Just bought Monster. Hypothetically speaking, and Coca-Cola has more distribution channels, which is why there's more monsters everywhere. And now we've got all this redundancy. So what do we do? Well, we have to. We know that revenue growth accelerated for Monster once Coke bought them because again, Coke's got additional distribution channels. But we've got to make some cuts. We've got to make some tough decisions. And so the CFO from Monster is going to be let go. And the CEO actually of Coca Cola, that's surprising me. Let go, because the CEO at Monster, hypothetically speaking, of course, is is a better CEO. And then we'll do the rest for the rest of the positions. And usually the acquiring company wins these battles and is the last person standing. So here are some steps to work on an M&A model. So on the income statement, it's pretty easy. You add the revenue together and then you assume there's overlap or or an increase in revenue because there's new distribution channels. Right. So Monster is now going to be sold in many different distribution channels. Given the fact that Coke, hypothetically speaking about the company and on the income statement, it's also easy with expenses, you simply add them together and then you assume what the overlap is. And you can also trim a lot of fat once you realize what the overlap is going to be. And on the balance sheet, it's really easy. Again, you add everything together, right? And then you cut and consolidate, right? So if you look at the property, property, plant and equipment section on the balance sheet, you don't need two factories, so maybe you can shut one down, that sort of thing. And every single company in every merger situation is completely different. That's why I want to talk about it from a high level perspective. On the cash flow statement, you just add everything together. Again, it's pretty simple. That's it. It's that easy. It is really easy. It's actually a lot of fun to. I enjoy it. And again, don't worry if you have no idea what's going on because management's going to walk you through every single cell in your model. So again, you've got to include many, many different comments asking you shall receive. Management wants to help you because you're helping them. Okay. So, again, we talked about Linda. The revenue was 122 million in 2013, 150 million in 2014, and 108 million to date or so in 2015. So we threw all that in our model. I already showed you that. In terms of expenses. You just got to ask LinkedIn and Linda together what expense cuts might what they might be and just reduce them from your combined model. You can make assumptions yourself, but it's best you talk to management because they will help you out with this. And so, again, big companies, when they buy small companies like Coke buying Monster, it's accretive, meaning earnings are going to go up for Coke, even though the valuation on Monster, for example, is way, way higher than Coke. And this is what happens with Hewlett-Packard as well. Hewlett Packard has 60% of the revenues overseas and 40% in the United States. And so when Hewlett-Packard buys a very expensive software company that is us focused only, it becomes immediately accretive, meaning it helps the earnings right away and the valuation right away, too, because HP has international distribution channels, they can distribute the product of the underlying software company. They just bought to 60% of their customers, which are overseas in this hypothetical example. Let's look at an example now of Apple from an M&A perspective. Let's have fun with this. Okay. So we have Apple. They've got a low price earnings multiple. It's cheap. Right. And over 60% of Apple sales are international. Okay. So Apple is going to buy Beats by Dre. And sorry, I have to put some humor in this. There we go. Beats by Dre. They want to look to buy that company. But hypothetically speaking, Beats has a very high P assuming Beats was just assuming it was publicly traded. A very high price earnings multiple and. Beats has way under 50% in this example of revenues from international. So Apple takes a bite out of beats. They buy the company. And what happens is there is a there are a ton of synergies. So Apple plus beats equals more than Apple plus beats one plus one equals three because apple can distribute beats headphones which are massive all over the world and their own distribution channels or in all of their Apple stores. Right. So revenue goes up a lot for beats itself. One plus one equals three in this hypothetical example. Now this is the hypothetical discussion of the income statement for Apple buying beats. So we're going to put together an income statement here. It's going to be very simplistic. Less is always more. All right. So Apple has revenues of 100 bucks. For example, cost goods sold of 20 bucks. DNA of ten bucks. Sales marketing 15 bucks. Research development, which is also called product development. Ten bucks. An EBITDA of 45 bucks. And taxes of 15. I guess 15 over 45 means a 33% tax rate and that's their net income. All right. And this is what Beats has lower revenue because it's a smaller company. And these are all just hypothetical numbers. Right. And you go all the way down and beats doesn't pay tax because they have net operating loss carryforwards, meaning they've lost money in the past. So they don't have to pay taxes until they make up for the money they've lost in the past. Again, that's called an NOL or net operating loss carry forward. Okay. So we just added the income statements together and look at this 100 plus 210 equals 220. Say what? Well, Apple can distribute beats products in many more markets. That Beats is not in. So instead of it just being 110 million revenue, it's 120. Got it. Okay, cool. So we can look at the percentage of revenue for each line item as well. And remember, when you model stuff. Spend a lot of time on revenue because everything else just becomes a percent of revenue. It's cake. It's really, really easy. Okay, let's do it. All right. So when we combined the companies here, right, you can see that the cost of goods sold 20 plus four equals 24. Right. And still, that's still 20% of revenue. G and a ten bucks plus one equals 11. That's 9% of revenue. Sales of marketing. Watch this. 15 plus two is 17, but it's actually 16 because they're able to trim a little bit here. There's overlap, research and development, ten plus 11. Looks like Apple is just going to stick with their own R&D and get rid of the R&D folks here, hypothetically speaking. All right. Interesting, huh? So look what just happened there. R&D used to be 10% of revenue. Now it's actually only 8%, right? Isn't that cool? Okay. Interesting. And EBITDA as a percentage of revenue was 45% or 45 bucks. And you had 20% EBIT margins, four beats EBIT. Remember, it means earnings before income taxes, depreciation and amortization if it exists. Add these together 45 plus two wo. It gets to be a lot bigger. Look at that. Look how creative this was. So the EBIT margins for Apple, again, hypothetically, is 49%, right? It's amazing. It used to be only 45%, huh? And despite the fact that Beats had brutal EBIT margins at Apple, it was still accretive. Interesting. Interesting. And looks like the tax is a little bit less for Apple as well. Why? It's a little bit complicated, but instead of being 33%, what they're doing is they have a tax loss carry forward because beats lost a lot of money before. Right. So they get that benefit as well. They bought that company. They get the benefit of that of purchasing that asset. And so the bottom line is net income as a percent of sale went from 30% to 33%, a highly accretive acquisition for Apple. And it made a lot of sense. And Wall Street loved it. So sometimes companies can buy other companies and instead of the stock going down of the company, acquiring the other company, it can actually go up if Wall Street likes it. And usually when company buys company B, if it's a big deal, they do it after the market closes. Say it for they'll announce that 405 pm New York time when the stock markets closed and then they'll hold a webcast that everybody can listen in to you, me, fidelity, the whole world. And they'll walk through why they did the deal and why it's accretive so that investors don't panic. They do it after hours, the markets close and hopefully the next day the stock goes up. Doesn't always happen. You know, investors sometimes don't like it because sometimes the big software companies or big companies in general will buy other companies because they're not growing themselves and they want to hide the fact that they're not growing, which is disingenuous. But the smart investors like you will catch on to that right away and sell the stock the next day or whatever. Okay. So we found the synergies and there they are. Pretty cool. Pretty cool. The only place we didn't have synergies was cost of goods sold. I don't know why. Maybe we didn't want to close that factory yet. Anyway, that's. That's it. Now we're working on this M&A deal. We're going to look at the balance sheet. So we have assets plus or assets equals liabilities plus equity, always rights. See, 11 plus four is 15. And here we have the cash buildings, liabilities, etc. for for beets. Remember equity plus liabilities equals assets and then we combine them and so wow. How did we get an increase in cash? Let's go through this. Ten plus one is not 13. So what happened was Apple. Pay down the debts. Right. From Beats. And then they sold three buildings. I get it. So they bought beats. Ten plus one is 11 bucks. 11 bucks. And then they paid the debt off here, the loans. So we're back down to ten bucks. And then Apple sold three buildings. So that's 13 bucks in cash. Okay. I get it. I get it. I get it. Okay. Make sense? Makes sense. That's fine. They sold some of their own assets as well. It looks like here debt is going to be zero because they pay back a dollar in debts and then looks like they're going to cut one employee. So we got four bucks here. Remember, assets, equal liabilities plus equity. So 11 plus four is 15 which which adds up again, hypothetical situation. So let's move on to the cash flow statement. Apple's cash flow from operations is ten bucks and that's the delta, right? Because their net income went from 30 bucks to 40 bucks. Let's go back a couple of slides here and I'll show you that. Okay. All right. Yeah. There you go. See Apple. Net income went from 30 to 40 bucks. All hypothetical here. High level, of course. All right. Go back to our cash flow statement. That makes sense. Cash flow from investing is three bucks because Apple sold three of Monster's plants. They get a $3 benefit and then cash flow from financing is nothing because they retired one of monsters debt, whatever, buck and debt. And then they use monsters cash to do that. Right. So there's no change there. So net net, the increase on the cash balance, 13 bucks post the monster deal.