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Investment Banking
University of Colorado
Rob Kaufman
November 3, 2004
Investment Banking Agenda
• Overview of IB industry
• Perspectives on market risk
• Valuation perspective
• Case study: .com valuation
• Case study: Sell-side M&A
• Q&A
Investment Banking Agenda
• Overview of IB industry
• Perspectives on market risk
• Valuation perspective
• Case study: .com valuation
• Case study: Sell-side M&A
• Q&A
RWK Bio
Rob Kaufman• BA in Economics, Yale University (1981-85)• International Capital Markets, Goldman Sachs
(85-89)• MBA in finance, Harvard Business School (1989-
91)• Partner, Sierra International Partners (1991-
1995)• Partner, The Wallach Company (1995-1999)• CFO and CEO, netLibrary, Inc. (1999-2002)• Partner, Q Advisors LLC (2002-present)
Sales/Trading
• Public company research
• Stock brokers
• Retail/institutional sales coverage
Corp. Finance
• Corporate and municipal issuance of equity/debt
• Capital markets
Investment Banking
• Private placements
• Mergers and acquisitions
• LBOs, MBOs
Hybrid Securities
Overview of the I-Banking Industry
Investment Banking Agenda
• Overview of IB industry
• Perspectives on market risk
• Valuation perspective
• Case study: .com valuation
• Case study: Sell-side M&A
• Q&A
An attempt to define the expected return which
corresponds to investments at various levels of risk.
Perspectives on market risk
• The Risk/Reward Frontier• Required Rates of Return• Developing an appropriate
discount rate for an investment decision
Risk/Reward Relationship
An attempt to define the expected return which to corresponds investments at various levels of
risk
Risk/Reward Frontier
Low RISK
U.S. T-Bills
Low RISK High
U.S. T-Bills Seed-Stage VC
Risk/Reward Frontier
An attempt to define the expected return which to corresponds investments at various levels of
risk
Seed Stage Venture CapitalStart-up Venture CapitalEarly Stage Venture CapitalPrivate EquityMezzanine Debt“Junk” BondsSenior Debt Small Capitalization Equities Large Capitalization Equities U.S. T-Bills
High
RISK
Low
Risk/Reward Frontier
Expected Annual Returns
50%+40-
50%35-
45%25-
35%18-
25%14-
20%8-12%
14-18%10-
14%4-5 %
Seed Stage Venture CapitalStart-up Venture CapitalEarly Stage Venture CapitalPrivate EquityMezzanine Debt“Junk” BondsSenior Debt Small Capitalization Equities Large Capitalization Equities U.S. T-Bills
High
RISK
Low
Risk
Return
• Venture Capital
• U.S. T-Bills
• Large Cap Equities
• Small Cap Equities
• Senior Debt
• Mezzanine Debt
• Private Equity
Required Rates of Return
Investment Banking Agenda
• Overview of IB industry
• Perspectives on market risk
• Valuation perspective
• Case study: .com valuation
• Case study: Sell-side M&A
• Q&A
Valuation perspective
Why is valuation important?
• Fundamental to all boutique investment
banking work
• Private placements require premoney
valuation
• M&A work requires relative value of
acquirer/acquiree
• Financing of transactions requires
fundamental understanding of value
Methodologies• Public Comparable Analysis
• Control Transactions
• Discounted Cash Flow Analysis
Valuation perspective
Public Comparable Analysis
• Select publicly-traded comparable companies
• Analyze financial and operating performance
• Derive valuation multiples for minority positionbased on performance of comparables
• Adjust for size/liquidity discount and control premium
Control Transactions
• Collect historical transactions in SIC Codes
• Compute financial performance of targets
• Derive valuation multiples from disclosed information (multiple of sales, EBIT, EBITDA, NI)
• Adjust for size discount • Apply multiples to target
Discounted Cash Flow Analysis
• Develop financial model with aid of management
• Projected after-tax, free cash flows, discounted to present
• Terminal value calculated as a multiple of final year Operating Profit, discounted to present
• Appropriate discount rates applied to cash flows and terminal values
• Appropriate terminal value multiples applied to final year profit
Investment Banking Agenda
• Overview of IB industry
• Perspectives on market risk
• Valuation perspective
• Case study: .com valuation
• Case study: Sell-side M&A
• Q&A
Case study: .com valuation
Valuations gone haywire: 1998-2000
Case Study: netLibrary, Inc.
Case study: netLibrary, Inc.
The netLibrary Story• Founded 1998, three founders
• Raised $120+ million
• Grew to 520+ employees in March
2000
The netLibrary Story• Founded 1998, three founders
• Raised $120+ million
• Grew to 520+ employees in March 2000
• Reduced headcount to 122 in September
2001
• Sold in Chapter 11 for $10 million
• Zero capital returned to investors,
shareholders
Case study: netLibrary, Inc.
Founding• Founded 1998, three founders
• Create an ASP model for reference
content
• Compete in $5+ billion market for
published content from leading
publishers into institutional libraries in
academic, public and corporate libraries
• Early support from University of
Colorado libraries and University Press
• Raised $5 million 8/98 Anschutz and
Sequel
Case study: netLibrary, Inc.
Growth• Bring on CFO in February 1999
• Raising venture funds
• Requirements:
Executive Summary
PowerPoint
• Challenges
Too many interested parties
Valuation ramping too high/too
quickly
Case study: netLibrary, Inc.
Funding• Venture funding
• Series A, $5 million at $5 million
premoney
• Series B, $25 million at $40 million
premoney
• Series C, $72 million at $225 million
premoney
• Series D, $15 million at $450 million
premoney
• Public offering
• CSFB/Merrill Lynch/JP Morgan
• Timing April 2000
Case study: netLibrary, Inc.
Restructuring• Headcount reduction
• Focus on customers/publishers and
not investors
• Aggressive move toward EBITDA
positive
• Move toward sale of Company as
endgame, not IPO or organic growth
Case study: netLibrary, Inc.
Lessons LearnedRunning the business
• Meet customer needs, not
investor/buyer needs (“Built to
Flip”)
• “Traditional” business
requirements apply
Financial
• Cost of capital higher valuation
needs to be earned
• Beware competing stage investors
Case study: netLibrary, Inc.
netLibrary Epilogue• Investor conflict
• Series A/B aligned against Series
C/D
• Buyers identified (three @ $40-50
million)
• Conflict over the “cram down”
• Sale in Chapter 11 bankruptcy despite
cash in bank
• Currently 60+ employees, $20+ million
revenue and still EBITDA positive
Case study: netLibrary, Inc.
Investment Banking Agenda
• Overview of IB industry
• Perspectives on market risk
• Valuation perspective
• Case study: .com valuation
• Case study: Sell-side M&A
• Q&A
Sale/Merger Characteristics
• Must possess strategic/financial value to buyer
• Established product/service and installed customer base
• Management team optional• Proprietary process or technology
preferred• Opportunity for moderate growth or
enhanced market share• Sufficient company size
Case study: Sell-side M&A
Advantages• Value could be the highest of
alternatives• Greatest liquidity of
Alternatives• Possibly tax-deferred
exchange• No Publicity if private
transaction• Complete exit from business• Moderately expensive
transaction costs
Disadvantages• Loss of Control• Management could be
dramatically affected• No “upside” for future
performance for 100% sale
• You could be unemployed
• Your company could lose its identity
Case study: Sell-side M&A
Case study: Gates Rubber Company
Facts• World’s leading manufacturer of rubber
hoses and belts with revenues of over $1.5 billion
• Family owned business• Desire for a tax deferred transaction• IBer had completed seven other
assignments for Gates
Case study: Gates Rubber Company
Facts• World’s leading manufacturer of rubber
hoses and belts with revenues of over $1.5 billion
• Family owned business• Desire for a tax deferred transaction• IBer had completed seven other
assignments for Gates
Assignment• Conduct a worldwide sale process to a
limited number of strategic buyers
Facts• World’s leading manufacturer of rubber
hoses and belts with revenues of over $1.5 billion
• Family owned business• Desire for a tax deferred transaction• IBer had completed seven other
assignments for Gates
Assignment• Conduct a worldwide sale process to a
limited number of strategic buyers
Result• Nine entities approached; three final
offers • Sold to Tomkins PLC for a package of
securities valued at $1.2 billion
Case study: Gates Rubber Company
Investment Banking Agenda
• Overview of IB industry
• Perspectives on market risk
• Valuation perspective
• Case study: .com valuation
• Case study: Sell-side M&A
• Q&A
Investment Banking
University of Colorado
Rob Kaufman
November 3, 2004
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