u.s. capital markets and corporate finance prof ian giddyigiddy/bouygues.pdf · ·...

Giddy/Bouygues Capital Markets & New Economy 1

U.S. Capital Marketsand

Corporate Finance

Prof Ian GiddyNew York University

NYU/Bouygues

Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 3

Three Issues inGlobal Corporate Financing

l Financing European and American Enterprisesu The New European Capital Marketu Capital markets in USA and Asiau Venture Capital and Corporate Venturing

l Shareholder Value and the "Cost of Capital"u Why shareholder value mattersu Why the “cost of capital” matters

l Mergers, Acquisitions and Divestituresu How the market values acquisitions and divestituresu Where the money comes from



Managing Corporate Finance

BankFinancing

BankFinancing

Risk ManagementInstruments

Risk ManagementInstruments

CapitalMarkets

CapitalMarkets

Corporate FinanceNeeds








Banking and Capital Markets:Europe vs. USA

l Banks vs. Marketsl Relationships vs. Transactionsl On Balance Sheet vs. Offl Domestic vs. Regional vs. Globall Debt vs. Equityl Bricks vs. Bytes


Banks vs. Markets

l Where are investors going?l What do today’s shareholders expect?l Where are corporations going?l Where is your banker going?

l Common theme: “The end ofentitlement” (which implies the end ofspecial responsibilities)



Relationships vs. Transactions

l Lower barriers to entry – more pricecompetition

l Frequent re-calculation of benefits: “What willyou do for me next?”

l Shareholder pressure weakens traditionalrelationships, obligations

l In business, the effect is toward alliances,contract manufacturing, out-sourcing

l Stability requires “new communities,” themore broadly-based the better


Financial Innovationand the Shorter Product Life Cycle

l More financial innovationl But most innovations faill Fewer geographic barriers to entryl Fewer information barriers to entry

Excessreturns

Time



Innovation as Value Creation

l Innovations are costly to develop andproduce, and easily copied, so

l For an innovation to succeed, it mustcreate differentiated value for issuer,investor, or risk manager, by:uUnbundling: create simple, more primitive

instruments to isolate risks, or

uBundling: create tailor-made instrumentsto reduce costs, minimize taxes, orcircumvent restrictions or imperfections.


On Balance Sheet vs. Off

l “All my assets are for sale, all the time”l Maximize ROE by increasing capital

turnover – become originators insteadof lenders

5,4 5,71,6

5,39,1 6,9

33,135,4

38,8

61,7

0,0

10,0

20,0

30,0

40,0

50,0

60,0

70,0

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999(YTD)

Market value of transactions in Europe (1990-present) Euro bn

Asset-BackedSecurities

Asset-BackedSecurities



Domestic, Regional or Global?

l Which are more mobile?uGoods markets

uLabor

uServices

uFinancial services

l Even domestic institutions must be ableto compete in the world arena


Debt vs. Equity

0.1

1

10

100

1000

10000

1925 1935 1945 1955 1965 1975 1985 1995

Index ($)

$4,495.99

$33.73

$13.54$8.85

$1,370.95

Small CompanyStocks

LargeCompanyStocks

Long-TermGovernmentBonds

Treasury BillsInflation Year-End

A $1Investmentin DifferentTypes ofPortfolios:1926-1996



Passive vs. Active Investors

l It’s an internet information agel Domestic shareholders want global

returns – asset managers must beatbenchmarks

l Corporations or financial institutionswhich cling to underperforming assetswill have lower ROE and share prices

l Which makes them vulnerable torestructuring or takeover – Europe’snew market for corporate control


Passive vs. Active Investors

uInvestors expect results or sell their shares;“friendly holdings” become too costly,opportunity costs become explicit

uVenture capital, private equity funds attractinvestors by offering higher returns

uMarket-based returns now expected byinvestors and lenders, and required ofmanagers; local differences persist, butdiminishing



Bricks vs. Bytes

l It’s a Nasdaq world, and it’s moving at“internet time”

l The old economy needs the neweconomy to meet shareholderexpectations

“To B2B, or not to be?”l E-business or m-business?l Equity, not debt, is financing the new

economy

Check your ownbank’s onlineand mobilefinancial services

Check your ownbank’s onlineand mobilefinancial services


Whither European Financial Services?

l The Anglo-Saxon model of transparentfinancial markets is coming, at internetspeed

l All assets must meet the test of themarket – global shareholder returnstandards

l Otherwise…



Example: Deutsche-Dresdner

l What is Deutsche’s strategy?l Does the Dresdner acquisition advance

that strategy?l What does it take to succeed in

investment banking?

Deutsche-Dresdner case study


The Commercial Banking Model

Assets Liabilities

Loansn Net interest

revenues

Loansn Net interest

revenues

Depositsn Net interest

costs

Depositsn Net interest

costs

Goal: Add assets with positive net interest margin



The Investment Banking Model

Sales

CapitalMarkets

CorporateFinance

Customer-DrivenSecurities

Goal: Originate deals and sell them in the capital marketas quickly as possible


The Asian Bet

l High growth disguised speculativefinancing structures

l Governments shielded companies andbanks from capital market discipline

l Too much debtl Too much foreign-currency debtl Closely held ownership relying on

reinvested earnings



The Asian Bet

l High growth disguised speculativefinancing structures

l Governments shielded companies andbanks from capital market discipline

l Too much debtl Too much foreign-currency debtl Closely held ownership relying on

reinvested earnings

The three excessesn Too much debtn Too much laborn Too much capacity

The three excessesn Too much debtn Too much laborn Too much capacity


Corporate Finance

CORPORATE FINANCEDECISONS

CORPORATE FINANCEDECISONS

INVESTMENTINVESTMENT RISK MGTRISK MGTFINANCINGFINANCING

CAPITAL

PORTFOLIO

M&ADEBT EQUITY

TOOLS

MEASUREMENT



The CFO Questions

l How fast can we grow? What criteria forspending money? Acquisitions? Divestitures?

l How should we finance our growth? What kindof equity?

l How much (cheap) debt should we have?

l What kind of debt should we have? Maturity?Fixed/floating? Currency? Asset-backed?Hybrids, such as convertibles?

l How should we manage our financial risks?

l What’s our plan for creating shareholder value?


Corporate Financing Life-Cycle

Growth companies Mature companies

Leverage



Firm Characteristics as GrowthChanges

Variable High Growth Firms tend to Stable Growth Firms tend toRisk be above-average risk be average risk

Dividend Payout pay little or no dividends pay high dividends

Net Cap Ex have high net cap ex have low net cap ex

Return on Capital earn high ROC (excess return) earn ROC closer to WACC

Leverage have little or no debt higher leverage

Earnings

Gearing

0








The Goal of Financial Management

l What are firm decision-makers hired to do?“General Motors is not in the business of making

automobiles. General Motors is in the business ofmaking money.”

Alfred P. Sloan

l Possible goals: Size, market share, profits

l Three equivalent goals of financialmanagement:uMaximize shareholder wealthuMaximize share priceuMaximize firm value


The Goal of Financial Management

Value-based management drives our performance

targets and incentives. We have set

ambitious short and medium-term financial

and operating targets and, to help meet

these, have aligned the interests of

management and employees with those of our

shareholders and customers. Our incentive

systems are linked to key aspects of

shareholder value, such as margins and

asset productivity. Our strategic focus is

centred on profitable growth, better

margins through innovation and higher

productivity, improved asset management,

and turnarounds in operations whose past

performance has not been world class.

Onecompany’sstatement



First Principles of CreatingShareholder Valuel Invest in projects that yield a return greater than the minimum

acceptable hurdle rate.u The hurdle rate should be higher for riskier projects and reflect the

financing mix used - owners’ funds (equity) or borrowed money(debt)

u Returns on projects should be measured based on cash flowsgenerated and the timing of these cash flows; they should alsoconsider both positive and negative side effects of these projects.

l Choose a financing mix that minimizes the hurdle rate andmatches the assets being financed.

l If there are not enough investments that earn the hurdle rate,return the cash to stockholders.u The form of returns - dividends and stock buybacks - will depend

upon the stockholders’ characteristics

l Minimize unnecessary financial risks.

Objective: Maximize the Value of the Firm


The Classical Objective Function

STOCKHOLDERS

Maximizestockholderwealth

Hire & fire managers- Board- Annual Meeting

BONDHOLDERS

LendMoney

ProtectbondholderInterests

FINANCIAL MARKETS

SOCIETYManagers

Reveal informationhonestly and on time

Markets are efficient and assesseffect on value

No SocialCosts

Costs can betraced to firm



What Can Go Wrong?

STOCKHOLDERS

Managers puttheir interests overshareholders’

Have little controlover managers

BONDHOLDERS

LendMoney

Bondholderscan getripped off

FINANCIAL MARKETS

SOCIETYManagers

Delay bad news orprovide misleadinginformation

Markets makemistakes and canoverreact

SignificantSocial Costs

Some costscannot betraced to firm


A Contrast: Disney vs. Campbell Soup

BEST PRACTICES CAMPBELL SOUP DISNEYMajority of outside directors Only one insider 7 of 17 members

among 15 directors are insiders

Bans insiders on nominating Yes No: CEO is

committee chairman of panel

Bans former execs from board Yes No

Mandatory retirement age 70, with none None

over 64

Outside directors meet w/o CEO Annually Never

Appointment of 'lead director'' Yes No

Governance committee Yes No

Self-evaluation of effectiveness Every two years NoneDirector pensions None Yes

Share-ownership requirement 3,000 shares None



Overpaying on Takeovers

l The quickest and perhaps the most decisive way toimpoverish stockholders is to overpay on a takeover.

l The stockholders in acquiring firms do not seem toshare the enthusiasm of the managers in these firms.Stock prices of bidding firms decline on the takeoverannouncements a significant proportion of the time.

l Many mergers do not work, as evidenced by anumber of measures.u The profitability of merged firms relative to their peer groups,

does not increase significantly after mergers.u An even more damning indictment is that a large number of

mergers are reversed within a few years, which is a clearadmission that the acquisitions did not work.


What’s a Company Worthto Another Company?

l Required Returnsl Types of ModelsuBalance sheet modelsuDividend discount & corporate cash flow

modelsuPrice/Earnings ratiosuOption models

l Estimating Growth Ratesl Application: How These Change with

M&A

BouyguesBouygues



Equity Valuation:From the Balance Sheet

Value of Assetsn Bookn Liquidationn Replacement

Value ofLiabilities

n Bookn Market

Value of Equity

BouyguesBouygues


Relative Valuation

l Do valuation ratios make sense?• Price/Earnings (P/E) ratios

q and variants (EBIT multiples, EBITDAmultiples, Cash Flow multiples)

• Price/Book (P/BV) ratiosq and variants (Tobin's Q)

• Price/Sales ratios

l It depends on how they are used -- andwhat’s behind them!



Valuing a Firm with DCF:An Illustration

Historicalfinancialresults

Adjust fornonrecurringaspects

Gaugefuturegrowth

Adjust fornoncashitems

Projected salesand operatingprofits

Projected free cash flowsto the firm (FCFF)

Year 1FCFF

Year 2FCFF

Year 3FCFF

Year 4FCFF

Terminal year FCFF

Stable growth modelor P/E comparable

Presentvalue of freecash flows

+ cash,securities &excess assets

- Marketvalue ofdebt

Value ofshareholdersequity

…

Discount to present using weightedaverage cost of capital (WACC)


More Simply, Invest Only When

Returnon

Assets

Cost ofFinancingexceeds








Goals of Acquisitions

Rationale: Firm A should merge with Firm B if[Value of AB > Value of A + Value of B + Cost

of transaction]l Synergyl Gain market powerl Disciplinel Taxesl Financing



Fallacies of Acquisitions

l Size (shareholders would rather havetheir money back, eg Credit Lyonnais)

l Downstream/upstream integration(internal transfer at nonmarket prices,eg Dow/Conoco, Aramco/Texaco)

l Diversification into unrelated industries(Kodak/Sterling Drug)


Do Acquisitions Benefit Shareholders?Successful Bids

Technique Target Bidders

Tender offer 30% 4%Merger 20% 0Proxy contest 8% na

n Note: Abnormal price changes are price changes adjusted toeliminate the effects of marketwide price changes



Do Acquisitions Benefit Shareholders?Unsuccessful Bids

Technique Target Bidders

Tender offer -3% -1%Merger -3% -5%Proxy contest 8% na


The Price: Who Gets What?

Daimler Chrysler Combined

Market value before dealleaked

$52.8 $29.4 $82.2

Value added by merger $18.0

Merged Value $100.2

Shareholders get 57.2% 42.8% 100%

Which is now worth $57.3 $42.9 $100.2

Shareholders' shares ofthe gain

$4.5 $13.5 $18

Premium, as % 9% 46%



When Shareholders GainFrom an Acquisition

Gains from merger

Synergies Control

Top line Financialrestructuring

BusinessRestructuring

(M&A)

Bottom line


What is Corporate Restructuring?

l Any substantial change in a company’sfinancial structure, or ownership orcontrol, or business portfolio.

l Designed to increase the value of thefirm

Restructuring

Improvecapitalization

Change ownershipand control

Improvedebt composition



It’s All About Value

l How can corporate and financialrestructuring create value?

Operating

Cash

Flows

Debt

Equity

Assets Liabilities

Fix thebusiness

Or fix thefinancing


Restructuring

What mix of debt is best suited tothis business?

Fix the kind of debt or hybridfinancing

What can be done to make theequity more valuable to investors?

Fix the kind of equity

Value the changes new controlwould produce

Fix management or control

Revalue firm under differentleverage assumptions – lowestWACC

Fix the financing – improve D/Estructure

Value the merged firm withsynergies

Fix the business – strategic partneror merger

Value assets to be soldFix the business mix – divestitures

Use valuation model – present valueof free cash flows

Figure out what the business isworth now



Getting the Financing RightStep 1: The Proportion of Equity & Debt

Debt

Equity

n Achieve lowestweighted averagecost of capital

n May also affect thebusiness side


Getting the Financing RightStep 2: The Kind of Equity & Debt

Debt

Equity

n Short term? Long term?n Baht? Dollar? Yen?

n Short term? Long term?n Baht? Dollar? Yen?

n Bonds? Asset-backed?n Convertibles? Hybrids?

n Bonds? Asset-backed?n Convertibles? Hybrids?

n Debt/Equity Swaps?n Private? Public?n Strategic partner?n Domestic? ADRs?

n Debt/Equity Swaps?n Private? Public?n Strategic partner?n Domestic? ADRs?

n Ownership & control?n Ownership & control?



The CFO Questions at Bouygues

l How fast can we grow? What criteria forspending money? Acquisitions? Divestitures?

l How should we finance our growth? What kindof equity?

l How much (cheap) debt should we have?

l What kind of debt should we have? Maturity?Fixed/floating? Currency? Asset-backed?Hybrids, such as convertibles?

l How should we manage our financial risks?

l What’s our plan for creating shareholder value?


Ian H. Giddy

Stern School of Business

New York University

44 West 4th Street, New York, NY 10012, USA

Tel 212-998-0332; Fax 917-463-7629

[email protected]

http://giddy.org

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