Investment Banking

Financial Services

Prof Shweta Anand

 What is an Investment Bank?
• Not a bank
• Helps in Organic Growth
– Help firms sell securities to public/QIB
• Stocks/Equity
• Bonds/Debt
– Transfers funds from public to firms
Savings -> Investments
Example: Goldman Sachs, Enam Financial consultants.
• Helps in inorganic growth
– Mergers and acquisition both for buyer and seller
 Investment Banking
• Provides strategic, financial and valuation
advisory services
• Raises capital through the issuance of securities
• Advises companies in merger & acquisition and
restructuring transactions
• Offers specialized products and services to meet
the needs of corporate and government clients
 Investment Banking Overview
• Provide strategic, financial and valuation advisory services
• Use industry knowledge, expertise and contacts to advise senior
executives and boards of directors
• Identify and assess strategic opportunities
• Interpret market information and enhance shareholder value
• Provide general valuation services (e.g., segment analysis, break-
up valuations,
• fairness opinions)

• Raise capital through the issuance of securities

• Act as intermediary between issuers and investors
• Provide access to equity and fixed income capital (e.g.,
investment-grade, bank,
• high-yield, preferred stock)
• Create specialized securities and derivatives (e.g., convertibles,
trust preferred
• securities, warrants)
 Investment Banking Overview
Advise companies in merger & acquisition and restructuring
transactions
• Sell-side assignments (represent client in sale of its company or
some of its assets)
• Buy-side assignments (represent potential acquirers and
negotiate transactions)
• Hostile take-over defense/advisory

Offer specialized products and services that satisfy the needs of

corporate and government clients
• Private equity (e.g., Merchant Banking, Real Estate, Venture
Capital, Other)
• Fixed income principal transactions
• Privatization
• Monetization
• Asset-backed securities
 M&A
• M&A Buy-side and Sell-
side advisory services
including target search
and advisory
Is Investment Banking same as Merchant Banking?
• In India
• In UK
• In US
The chief distinction between an investment bank and a
merchant bank is that a merchant bank invests its own
capital in a client company whereas an investment bank
purely distributes (and trades) the securities of that
company in its capital raising role. Both merchant banks
and investment banks provide fee based corporate
advisory services, including in relation to mergers and
acquisitions.
Initial Public Offering (IPO)
Initial Public Offer

•First sale of stock by firm

•Originating investment bank, key player in
bringing the shares to market
•Handles most administrative details,
reputation
 Role of Investment Bank
Investment bankers perform three main functions in the issuance of
stocks:

(1) Leading or managing the syndication, which is an organizing role,

(2) underwriting, which requires capital commitment and
(3) selling or distributing the securities to the public. One or more
investment bankers are managers (or lead underwriters). The
rest of the syndicate members may engage in underwriting
and/or selling.

The fee for the investment bankers is called gross spread and
averages 7% of the issue size.
 Investment Banks
• The investment bankers underwrite, manage
and sell the issue.
 Investment Banks
Investment banks to underwrite the security. If it
chose to engage an underwriter, there are two
types of contracts: best efforts and firm
commitment contracts. Under best efforts
contract, the firm assumes the risk of
distribution.
 Investment Banks
• The investment banker makes its best effort to sell the
issue and the company gets its capital net of
underwriter compensation piecemeal as each share is
sold. The investment bankers’ responsibilities are
managing the issue and selling.
• Under firm commitment contracts, the underwriters
buy the securities from the issuing firm and sell them to
the public. The firm gets its capital (net of underwriters’
compensation) immediately and the risk of distribution
is shouldered by the investment bankers
 Role of Investment Bank
• The gross spread is divided into the three functions
described above: management fee, underwriting fee
and selling concessions and each constitutes 20%, 20%
and 60% on average.
• Each member of the syndicate gets from these fees
depending on its participation and its contribution. If an
investment bank wins the contract from an issuing
company, manages, underwrites and sells the securities
alone, it can keep the entire fee.
 Syndicate
• So why would an investment banker invite
others to the syndicate and share its business
and its revenue?
 Probable reasons are
• (1) it needs to share the capital commitment
necessary to underwrite the security issue,
• (2) it needs to share the marketing effort to sell
the shares,
• (3) it needs to share expertise and skills in
securities underwriting to price the shares more
accurately,
 Probable reasons
• (4) it needs to establish business relations since those
invited to the syndicate would likely invite it when they
win future underwriting contracts, and
• (5) sometimes the issuing firm desires inclusion of some
investment banks in the syndicate.
These imply that size of the issue, risk ness of the issue,
the size and reputation of the investment banker, the
desire of partnership relations and complexity of the
issue determine the size and composition of an
underwriting syndicate
 IPO Methods
Three methods are most common globally for IPOs –

1) public offer (a.k.a. fixed price, open offer or universal offer),

in which the issue price is set first, and then orders are taken from
investors who typically pay in advance for part or all of the shares that are
ordered

2) a tender or auction; and

3) book building
in which the underwriters do road shows and take nonbinding orders from
investors before setting the issue price. Under the book building method,
the underwriter has substantial control over allocations and tends, in
practice, to favor regular investors and investors that provide information.

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 IPO Methods
The key difference between book building and other
IPO methods is that the book building method gives
underwriters control over the allocation of shares. In
contrast, auctions require allocations to be based on
current bids, without regard to any past relationship
between certain bidders and the auctioneer, and they
are usually open to everyone. The public offer method
normally includes "fairness rules" which limit
discrimination.

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 IPO Methods
• Global trend towards the use of the book building
method for IPOs.

In the 1980s, book building was used primarily in North

America. By the end of the 1990s, it was also the
dominant method in Europe, Asia and Latin America, at
least for larger issues. The public offer (a.k.a. fixed price
or open offer) method is becoming less common
worldwide but continues to be popular in smaller
countries that rely mainly on retail investors.

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 IPO Methods
• Hybrid offerings, with separate tranches using different
methods, are common. There have been hybrid
auction/public offer and auction/book building IPOs,
but by far the most common combination is book
building/public offer. For most hybrids, book building is
used to set the price and to allocate shares to
institutional and foreign investors, while a public offer
tranche is reserved for local retail investors who do not
participate in the price-setting process.

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TABLE 1: COMPARISON BETWEEN BOOKING BUILDING AND FIXED PRICE OFFERS

Book building Fixed price

Price band is fixed by issuer with the help of lead No price band. Offer price is fixed
managers prior to the offer. Investors have an option and investors apply at that
to bid within that band and final price is determined predetermined price
after closure of IPO
BSE brokers for bidding, who in turn submit to Applications submitted to bankers
bankers for processing directly
Investor has an option to revise the bid No such option
The bidding details called as transaction registration No such procedure. Only bankers
number are given by the broker to investors on acknowledge the application
request
Stock exchanges display data pertaining to book No such procedure
built issues on daily basis
Allotment is made within 15 days of IPO closure Allotment will take approximately
and listing on 21st day 25 days.

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 IPO Grading (Unlisted Companies)
• IPO Grading Compulsory from May 1, 2007
• Five-point point scale
• Higher score indicating stronger Fundamentals and vice versa
• All the grades to be disclosed
• Activity to run parallel to the filing of draft offer document
• Price of the IPO not taken into account for Grading
IPO Grade : Price Matrix First IPO Grading

High Grade High Grade • CRISIL

High Price Low Price
– Kiri Dyes and Chemicals Ltd – 2/5
(Subscription – 1.3 times)
• ICRA
Low Grade Low Grade
– KSK Energy ventures – 3/5
High Price Low Price
(Subscription – 1.48 times)

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 IPO Grading (Unlisted
Companies)
Factors Considered for IPO Grading
• Business Prospects and Competitive Position
• Industry Prospects
• Company Prospects
• Financial Position
• Management Quality
• Corporate Governance Practices
• Compliance and Litigation History
• New Projects — Risks and Prospects

Key Components of Investment Decision

Fundamental
Fundamental Returns
Returns Investor
Investor
Analysis
Analysis Analysis
Analysis Preference
Preference
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Thank You