Investment Banks

Investment Banks
• Investment banks perform a variety of

crucial functions in financial markets
– Underwrite the initial sale of stocks and bonds
– Deal maker in mergers, acquisitions, and
spin-offs
– Middleman in the purchase and sale
of companies
– Private broker to the very wealthy
Investment banking 1
Investment Banks
• Investment banks were essentially created in the

U.S. by the passage of the Glass-Steagall Act.
Prior to this, investment banking activities were
part of large, money-center commercial banks.
• The lines between investment banks and
commercial banks again begins to blur as legal
separation between investment banks and
commercial banks is no longer required.
Investment Banks
Investment banks play many roles in both the

primary and secondary markets. We will focus
on their role in three areas:
• Underwriting Stocks and Bonds
• Equity Sales
• Mergers and Acquisitions
But first, let’s look at the largest U.S.
underwriters.
Top Underwriters
Underwriting Stocks and Bonds
• The process of underwriting a stock or a bond

issue requires that the investment banker
purchase the entire offering at a predetermined
price and then resell the offering (securities) in
the market. The services provided during this
process include:
– Giving Advice
– Filing Documents
– Underwriting, Best Efforts, or Private Placement
• Giving advice
– Explaining current market conditions in to help
determine why type of security (equity, debt,
etc.) to offer
– Assisting in determining when to issue, how
many, at what price (more important with IPOs
than SEOs)
• Filing Documents
– SEC registration (filing) is required for issues greater
than $1.5 million and with a maturity greater than
270 days.
– A portion of the registration statement known as the
prospectus is made available to the public.
– Debt issues require several additional steps, including
acquiring a credit rating, hire a bond counsel, etc.
– For equity issues, the investment banker may also
arrange for the securities to appear on one of
the exchanges.
• Underwriting (firm commitment)

– The investment banker purchases the entire
offering at a fixed price and then resells the
offering to the market.
– An underwriter may form an underwriting
syndicate to diffuse part of the
underwriting risk.
– Placement of a tombstone in, for instance, the
Wall Street Journal (example on next slide).
• The goal of underwriting is for all of the

shares in an offering to be spoken for.
However, this may not occur.
– Fully subscribed: all shares are spoken for
– Undersubscribed: underwriting syndicate
unable to generate interest in all of the
available shares
– Oversubscribed: interest in more shares than
are available (may lead to rationing).
• Best Efforts: An alternative to a firm

commitment, the underwriter does not buy
the issue, but rather makes its “best effort”
to sell the entire issue.
• Private Placements: The entire issue is
sold to a small, select group of investors.
This is rarely done with equity issues.
• Equity Sales: when a firm sells an entire division

(or maybe the entire company), enlisting the aid
of an investment banker.
– Assists in determining the value of the division or firm
and find potential buyers
– Develop confidential financial statements for the
division for prospective buyer (confidential
memorandum)
– Prepare a letter of intent to continue, assist with due
diligence, and help reach a definitive agreement
Securities Underwriting in U.S.
U.S. Corporate Underwriting Activity

($ Billions)
3,000
2,500
2,000
1,500
1,000
500
Debt Equity
Source: http://www.sifma.org/research/statistics.aspx
Corporate Debt Equity Underwriting

($Billions) ($Billions)
3,000 300
2,500 250
2,000 200
1,500 150
1,000 100
500 50
0 0
Straight Corporate Debt Convertible Debt "True" IPOs Secondaries

Asset-Backed Debt Non-Agency MBS
Note: IPOs and secondaries are subsets of common stock. “True” IPOs exclude closed-end funds.

Non-corporate Borrowing
($Billions)
6,000
5,000
4,000
3,000
2,000
1,000
Treasury Agency Agency MBS
Mergers and Acquisitions
• Investment bankers may assist both

acquiring firms and potential targets
(although not both in the same deal).
• Deal may be a hostile takeover, where the
target does not wish to be acquired.
• Investment bankers will assist in all areas,
including deal specifics, lining up financing,
legal issues, etc.
Mergers and Acquisitions

Announced M&A by Target Nationality
2012 2011 % Volume
Target Nationality Volume $bn Deals Volume $bn Deals Change
United States 925.0 11,307 1,001.2 10,513 -8%
China 171.7 3,294 187.6 4,287 -8%
Canada 146.3 1,846 99.2 2,251 47%
United Kingdom 143.9 2,393 135.7 2,463 6%
Russia 117.1 2,114 81.6 3,013 44%
Japan 102.7 2,529 123.5 2,671 -17%
Australia 80.1 1,495 135.6 1,747 -41%
Germany 70.3 1,274 59.7 1,621 18%
Brazil 66.7 758 85.1 706 -22%
Switzerland 65.1 278 30.4 345 114%
Global Target Sector Ranking - 2012

Rank Target Sector Volume Deals % Change
$bn 2012 vs 2011
1 Oil & Gas 366.9 1,762 34%
2 Real Estate 243.2 3,092 -13%
3 Finance 218.4 2,727 -15%
4 Technology 202.3 5,985 -11%
5 Food & Beverage 192.1 1,503 114%
6 Telecom 173.4 1,050 -6%
7 Healthcare 163.4 2,537 -29%
8 Utility & Energy 155.7 1,290 -38%
9 Mining 140.8 2,086 -5%
10 Professional Services 85.4 4,504 44%
Source: Dealogic, Global M&A Review , Full Year 2012
Top M&A Players in 2012
Global M&A Volume Ranking – Announced Deals
Rank Advisor Value $bn Deals % Share 2011 Rank
1 Goldman Sachs 605.3 391 23.6 1
2 JPMorgan 466.7 300 18.2 2
3 Morgan Stanley 456.4 306 17.8 3
4 Citi 447.1 226 17.4 7
5 Barclays 403.1 214 15.7 6
6 Credit Suisse 401.6 255 15.7 4
7 Deutsche Bank 396.5 230 15.5 8
8 Bank of America Merrill Lynch 354.6 229 13.8 5
9 Rothschild 234.5 256 9.1 11
10 UBS 227.5 180 8.9 9
11 Lazard 179.7 221 7.0 10
12 Nomura 151.7 156 5.9 12
13 Evercore Partners Inc 119.5 103 4.7 14
14 RBC Capital Markets 112.3 177 4.4 17
15 HSBC 85.4 84 3.3 16
16 BNP Paribas 82.9 83 3.2 13
17 Mizuho 79.3 88 3.1 24
18 Centerview Partners 76.9 18 3.0 31
19 Jefferies & Company 71.4 129 2.8 19
20 VTB Capital 69.0 19 2.7 57

Largest M&A Transactions in 2012

Announced 22-Oct-12 7-Feb-12 2-Oct-12
Deal Status Pending Pending Completed
Target TNK-BP (50%) Xstrata (65.9%)
Kraft Foods
Group
Target Nationality Russia Switzerland United States
Acquiror Rosneftegaz Glencore Existing
International Shareholders
Acquiror Nationality Russia Switzerland United States
Target Advisor Parent UBS, Goldman Sachs, Goldman Sachs, Goldman Sachs,
Morgan Stanley, Deutsche Bank, Evercore
Renaissance Capital, Nomura, Barclays, Partners,
Lambert Energy Lazard, JPMorgan Centreview
Advisory Partners
Acquiror Advisor Barclays, Citi, Bank of Citi, Morgan -
Parent America Merrill Lynch, Stanley, BNP
VTB Capital, Deutsche Paribus, Credit
Bank Suisse
Deal Value($bn) 54.5 45.5 36.7

20
Top M&A Players 2013 (first half)
Global M&A Volume Ranking – Announced Deals
Rank Advisor Value $bn Deals % Share 1H 2012Rank
1 Goldman Sachs 299.1 142 25.4 3
2 JPMorgan 298.8 110 25.3 1
3 Morgan Stanley 220.6 127 18.7 2
4 Barclays 191.8 87 16.3 5
5 Bank of America Merrill Lynch 174.9 87 14.8 8
6 Credit Suisse 125.4 88 10.6 6
7 Deutsche Bank 122.9 77 10.4 4
8 Lazard 106.0 82 9.0 11
9 Citi 105.7 100 9.0 7
10 Moelis & Co 67.6 38 5.7 18
11 Evercore Partners 61.8 60 5.2 16
12 Centerview Partners 60.7 10 5.2 19
13 UBS 50.3 74 4.3 12
14 Rothschild 48.4 90 4.1 9
15 LionTree Advisors 48.1 4 4.1 179
16 Wells Fargo Securities 40.9 26 3.5 28
17 RBC Capital Markets 37.0 48 3.1 14
18 HSBC 29.6 29 2.5 15
19 Nomura 29.3 68 2.5 10
20 Jefferies 26.9 51 2.3 17
Source: Dealogic, Global M&A Review , First half, 2013

Securities Brokers and Dealers
Securities firms with brokerage services

offer several types of services:
• Brokerage Service
• Other services
• Full-Service Brokers versus
Discount Brokers
• Securities Orders: when you call a brokerage

house to buy or sell a security, you essentially
have three options:
– Market Order: buy or sell security at current price
– Limit Order: you specify the most you are willing to pay
(buy) or the least you are willing to accept (sell) for
a security
– Short Sales: sell a security you don’t own with the
intent of buying it back at a later date (hopefully at a
lower price)
• Other Services
– Insurance against loss of actual
security documents
– Margin credit for purchasing equity with
borrowed funds
– Other services driven by market demand (e.g.,
the Merrill Lynch cash management account)
• Full Service Brokers: offer clients research

and investment advice, but usually charge
a higher commission on trades.
• Discount Broker: provides facilities to
buy/sell securities but offers no advice.
Many on-line discount brokerage firms do
have significant research available
• Securities Dealers
– Hold inventories of securities on their
own account
– Provide liquidity to the market by standing by
ready to buy or sell securities (market maker)
– Especially important for thinly traded securities
Regulation of Securities Firms
Two acts passed in 1933 and 1934 provide the

primary basis of today’s markets. The major
provisions include:
• Establishment of the SEC
• Registration requirement for new securities
• Reporting requirements for companies
and insiders
• Prohibition of market manipulation
Relationship Between Securities Firms

and Commercial Banks
• Glass-Steagall stipulated that investment

banking and commercial banking would be
separated.
• G-L-B Act removed some of these barriers.
• Commercial banks are slowly gaining
regulatory permission to engage in
the full range of services offered by
investment banks.
Private Equity Investments
• An alternative to investing via public securities is

private equity (PE) investments. Here, a limited
partnership raises funds (PE) to invest in new
companies, to buyout existing divisions, etc.
• Most common types of PE are venture funds and
capital buyouts.
• PE got a boost in 1978 when pension funds were
permitted to invest in PE firms.
Venture Capital Firms
• These firms provide funds for

start-up companies
• Often become very involved with firm
management and provide expertise
Venture Capital Firms
• Description of Industry
– Typically limited partnerships
– Examples of venture-backed firms include
Apple Computer, Cisco Systems, Starbucks,
TCBY, etc.
• Table on next slide shows the level of

venture involvement in companies over the
last seventeen years.
Venture Capital Investments
Venture Capitalists Reduce Asymmetric
Information
• Managers of start-ups may have objectives that

differ significantly from profit maximization.
• Venture capitalists can reduce this information
problem in several ways
– Long-term motivation
– Sit on the board of directors
– Disburse funds in stages, based on required results
– Invest in several firms, diversifying some risk
Origins of Venture Capital
• First U.S. venture capital firm was established

in 1946.
• Most venture capital firms in the 1950s and
1960s funded development in oil and real estate.
• Funding has shifted from wealthy individuals to
pension funds / corporations. This is one
of the few risky investments pension funds
are permitted.
Structure of Venture Capital Firms
1. Most are limited partnerships

2. Source of capital includes wealthy
individuals, pension funds,
and corporations
3. Investors must be willing to wait years
before withdrawing money
Life of Venture Capital Deal
1. Fundraising
– Venture firm solicits commitments, usually less than
100 per deal
2. Investment phase
– Seed investing
– Early stage investing
– Later stage investing
3. Exit
– Usually IPO as merger
National Venture Capital Association
(click on Industry Research)
Investment banking http://www.nvca.com 36
Venture Profitability
• The 20-year average return is over 16.5%,

with seed investing providing the highest
average (20.4%) and later stage funding
providing the lowest (13.9%).
• Despite some phenomenal years (1999),
venture capital has had negative returns in
recent years.
Private Equity Buyouts
• In this situation, a public company (or

perhaps a division) is taken private. For
example, in mid-2007, Thompson Corp.
(NYSE: TOC) sold its Thompson Learning
division to Apax Partners and OMERS
Capital Partners in a private equity buyout.
The price tag? $7.76 billion in cash!
• Why go private?
– Avoid SEC regulation, such as Sarbanes-
Oxley.
– Provides flexibility and ability to avoid public
scrutiny of earnings. Also helps attract top
talent no longer interested in the life of a
public-company CEO.
– Tax advantages, and high compensation for
partners.
• Lifecycle of a Private Equity Buyout

– Investors pledge money (usually $1 million or
more) and intent to leave money in partnership
for 5+ years.
– Partners identify an opportunity, buy it, and
then manage its future (typically hire a CEO for
day-to-day operations).
– The company is then sold to the public via an
IPO.
• Implications of the Ownership Structure

– High risk and high returns are involved, as can
be seen in the next slide.
– As the market for underperforming firms
becomes more competitive, PE may not
perform as well, or industry will shrink.
Private Equity Returns
Chapter Summary
• Investment Banks: the role of investment

banks in issuing new securities and other
important roles was discussed.
• Security Brokers and Dealers: the
importance of dealers and brokers in
making markets and offering services to
investors was presented.
Chapter Summary (cont.)
• Regulation of Securities Firms: the primary

provisions of the two acts in 1933 and 1934
were summarized.
• Relationship Between Securities Firms and
Commercial Banks: with the changes in
legislation, the blurring of these two
industries was discussed.
Chapter Summary (cont.)
• Private Equity: the important roles that

venture capital firms play in young, start-up
companies was presented, as well as
venture structure and performance over the
last 20 years. We also looked at similar
ideas for private equity firms and the
private equity buyout process.

Investment Banks

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Investment Banks

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Investment Banks

• Investment banks perform a variety of

• Investment banks were essentially created in the

Investment banks play many roles in both the

• The process of underwriting a stock or a bond

Underwriting Stocks and Bonds

Underwriting Stocks and Bonds

• Underwriting (firm commitment)

Underwriting Stocks and Bonds

• The goal of underwriting is for all of the

Underwriting Stocks and Bonds

• Best Efforts: An alternative to a firm

• Equity Sales: when a firm sells an entire division

Securities Underwriting in U.S.

U.S. Corporate Underwriting Activity

Corporate Debt Equity Underwriting

Straight Corporate Debt Convertible Debt "True" IPOs Secondaries

Securities Underwriting in U.S.

Treasury Agency Agency MBS

• Investment bankers may assist both

Mergers and Acquisitions

Global Target Sector Ranking - 2012

Source: Dealogic, Global M&A Review , Full Year 2012

Largest M&A Transactions in 2012

Source: Dealogic, Global M&A Review , Full Year 2012

Source: Dealogic, Global M&A Review , First half, 2013

Securities Brokers and Dealers

Securities firms with brokerage services

• Securities Orders: when you call a brokerage

Securities Brokers and Dealers

• Full Service Brokers: offer clients research

Securities Brokers and Dealers

Two acts passed in 1933 and 1934 provide the

Relationship Between Securities Firms

• Glass-Steagall stipulated that investment

• An alternative to investing via public securities is

Venture Capital Firms

• These firms provide funds for

• Table on next slide shows the level of

Venture Capital Investments

• Managers of start-ups may have objectives that

Origins of Venture Capital

• First U.S. venture capital firm was established

1. Most are limited partnerships

Life of Venture Capital Deal

• The 20-year average return is over 16.5%,

Private Equity Buyouts

• In this situation, a public company (or

Private Equity Buyouts

• Lifecycle of a Private Equity Buyout

• Implications of the Ownership Structure

Private Equity Returns

• Investment Banks: the role of investment

Chapter Summary (cont.)

• Regulation of Securities Firms: the primary

• Private Equity: the important roles that

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