Posts Tagged ‘LBO’

TPG’s Bonderman Sees Mega LBO Coming – $10-15B Deal

Friday, March 4th, 2011

David Bonderman, the founder of TPG, claims that large deals are back, and they are back to stay.  Fueled by cheap credit and impatient investors, mega LBOs will return, and according to him, TPG will be at the forefront.  TPG has not been shy of these deals in the past, leading the $44 billion takeover of TXU with Goldman Sachs and KKR in 2007.  Surprisingly, investor memories are short, and the same leverage multiples and weak capital structures we saw in 2006 are emerging today in the private equity industry.  As takeover multiples rise, so will leverage.  And funny thing is, banks are willing to provide it more than ever.

“Larger deals are back,” Mr. Bonderman said Thursday at the SuperReturn conference in Berlin. “It is as I said before absolutely possible to do a 10-to-15-billion-dollar deal now. It might not be one you want to do. It might not be one you should do. But the capital is available.”

Recent private equity deals have been valued at $5 billion or less, a far cry from those of the 2006-2007 buyout boom. Indeed, in 2007 TPG teamed up with KKR and Goldman Sachs to buy the energy company TXU for $44 billion.

But money for private equity deals dried up in the financial crisis and the recovery so far has brought only smaller deals.

Among those deals is the $3 billion leveraged buyout of the preppy retailer J. Crew by TPG and Leonard Green & Partners, a deal that  was approved by the company’s shareholders this week.

Along with larger deals, Mr. Bonderman and other private equity executives at the SuperReturn conference were all abuzz about the potential of emerging markets.

Mr. Bonderman called emerging markets the “flavor of the month” and predicted that initial public offerings in emerging markets would represent an even larger proportion of the deals in years to come.

“Interesting enough, if you survey folks like all of us in this room, everybody sees emerging markets growing just about as fast as mature markets in the deal business, which of course has never been the case before now,” Mr. Bonderman said, adding that the upside potential for deals remained high.

Growth in emerging markets is being fueled by China’s booming economy, which could even be on the verge of a bubble, as well as broader trends, including the rise of the middle class in those regions, Mr. Bonderman said.

“Even Brazil is a China story,” Mr. Bonderman said, adding that the emerging middle class would add trillions of dollars to emerging economies, particularly on the consumption side. This should lead to a “huge rebalancing of how the world sees itself,” he said.

Mr. Bonderman was asked about TPG’s recent exit from the Turkish spirits company Mey Icki , which TPG acquired in 2006 for about $800 million and sold in February for $2.1 billion.

He responded: “We thought it was a good opportunity, and it turned out to be. We would have taken it public had Diageo not shown up. As in any other place, if you can sell the whole business, you’re better off than taking it public, where you have to dribble it out even though you might get a nominally higher value. We like Turkey as a place to invest and we’ll be back.”

On the sovereign crises, such as the one in Greece, Mr. Bonderman said: “When governments are selling, you should be buying. And when governments are defaulting, we should look at that as an opportunity. Prices are always lower when the troops are in the street. A good default, like Portugal or Greece, would be very good for the private equity business. Might not be so good for the republic, but it would be good for us.”

KKR & Bain to IPO HCA at $30 per Share – Mega IPO, Sponsors to make 2.5x on Deal

Friday, March 4th, 2011

HCA Holdings, the large hospital operator in the world, confirmed that it had set a preliminary price range for its initial public offering of $27 to $30 a share last month.  The company was taken private in 2006 for about $30 billion, with an equity check that was only 15% of its purchase price!  Last year, HCA’s $4.3 billion dividend recapitalization itself made many parties in the deal whole on their initial investment.  The IPO is gravy, icing on the cake.  And to top it all off, this had been done with the hospital operator before: “The company had been under private-equity ownership before, completing a $5.1 billion leveraged buyout in 1989. When it went public again in 1992, it handed its backers, including units of Goldman Sachs Group Inc. and JPMorgan Chase & Co., a more-than- eightfold gain, BusinessWeek magazine reported at the time.”

According to BusinessWeek, after a tepid turnout in 2010, there has been a modest uptick in buyout-backed offerings this year, with several exceeding expectations. Among the recent I.P.O.’s are Nielsen Holdings, Kinder Morgan and Bank United. HCA is currently pitching its offering to investors.

A private equity consortium, including Kohlberg Kravis Roberts, Bain Capital and Merrill Lynch, acquired HCA in 2006, loading the company up with debt. HCA, in its filing, said it planned to use proceeds from its offering to pay off some of its debt.

What a difference 10 months have made for HCA Inc. and its private-equity owners, KKR & Co., Bain Capital LLC and Bank of America Corp.

When the hospital operator, which went private in a record leveraged buyout in 2006, filed in May to go public, U.S. initial offerings were stumbling, with deals in the first four months raising an average of 13 percent less than sought. Rather than press ahead, the owners took on more debt to pay themselves a $2 billion dividend in November, in a transaction known as a dividend recapitalization.

This month, HCA’s owners are betting that stock markets have recovered enough for investors to pick up the shares, even with the additional debt. If they’re right, they may triple their initial investment in what would be the largest private- equity backed initial public offering on record.

“This has been a classic case of buy low, sell high from the beginning,” said J. Andrew Cowherd, managing director in the health-care group of Peter J. Solomon Co., a New York-based investment bank. “Private-equity buyers have timed capital markets perfectly on this deal.”

The offering, if successful, underscores the crucial role played by the capital markets in leveraged buyouts, at times eclipsing the impact of operational changes private-equity firms make at their companies. A surge in demand for stocks and junk- bonds, fueled by asset purchases of the Federal Reserve that sent investors searching for yield, have helped KKR and Bain reap profits from HCA, even as the company remains burdened with $28.2 billion in debt and slowing revenue growth.

Record Deal

KKR, Bain, Bank of America and other owners invested about $5 billion in equity in the $33 billion takeover of HCA, which including debt was the largest leveraged buyout at the time. The backers, who took out $4.3 billion in dividends from HCA last year as the high-yield market soared, stand to get more than $1 billion from the IPO and will retain a stake in HCA valued at about $11 billion.

In acquiring Nashville, Tennessee-based HCA, KKR and Bain chose a company with steady cash flow and a business that’s protected from swings in the economy. Cash flow from operations was $3.16 billion in the year before the 2006 buyout, according to data compiled by Bloomberg. As of Dec. 31, 2010, that number was little changed at $3.09 billion.

The company had been under private-equity ownership before, completing a $5.1 billion leveraged buyout in 1989. When it went public again in 1992, it handed its backers, including units of Goldman Sachs Group Inc. and JPMorgan Chase & Co., a more-than- eightfold gain, BusinessWeek magazine reported at the time.

Income Streams

Unlike some other buyouts of the boom years that had less predictable income streams, HCA has reported revenue growth of between 5 percent and 6 percent every year it was private, except in 2010, when growth slowed to 2.1 percent. Net income has increased 17 percent since the end of 2006.

NXP Semiconductors NV, another 2006 buyout involving KKR and Bain, had combined losses of $5.8 billion between the takeover and its IPO in August. NXP, which sold just 14 percent of its shares, had to cut the offering price, leaving investors with a 21 percent paper loss as of Dec. 31. The stock has more than doubled since the IPO.

HCA, the biggest for-profit hospital chain in the U.S., attributes gains in income to cost-cutting measures and initiatives to improve services for patients. The company sold some hospitals after the buyout and made “significant investments” in expanding service lines, as well as in information technology, HCA said in a regulatory filing.

‘Aggressive Changes’

“HCA was already one of the better operators when it was taken private so it was hard to see how much cost could be driven out of the business,” Dean Diaz, senior credit officer at Moody’s Investors Service in New York, said in a telephone interview. “But they are very good at what they do and are above where we would have expected on Ebitda growth.”

Some of the improvements in earnings have come from “aggressive changes in billing and bad debt expense reserves,” Vicki Bryan, an analyst at New York-based corporate-bond research firm Gimme Credit LLC, said in a Feb. 22 report.

Provisions for doubtful accounts dropped 19 percent last year, to $2.65 billion. Capital spending, or money invested in the company, declined to about 4 percent of revenue last year from 7 percent in 2006. The company hasn’t used its cash to bring down the debt load, which is about the same as it was at the time of the takeover.

That debt will contribute to a negative shareholder equity, a measure of what stockholders will be left with if all assets were sold and debts were paid, of $8.6 billion, according to Bryan. Excluding intangible assets, new investors buying the stock would own a negative $51 per share, she said.

‘Funding the LBO’

“Today’s HCA stock buyers are still funding the 2006 LBO, which enriched many of the same equity owners for the second time, plus the massive dividends and management fees paid to those equity investors who will remain very much in control,” Bryan wrote in the report.

While it’s not unusual for companies that exit LBOs to have more debt than assets, it means they will have to use cash flow to reduce debt rather than pay out dividends, limiting returns for shareholders. HCA’s share price doubled in the 14-year period between its 1992 IPO and the 2006 buyout, not including the impact of stock splits.

Ed Fishbough, an HCA spokesman, declined to comment, as did officials for New York-based KKR, Bain in Boston, and Bank of America in Charlotte, North Carolina.

‘Slight Premium’

Even so, investors may pick up the stock after U.S. equity markets rallied to the highest levels since June 2008. So far this year, eight companies backed by private-equity or venture- capital firms have raised $5.9 billion in initial public offerings, five times the amount that such companies raised last year, according to data compiled by Bloomberg.

At the midpoint of the price range of $27 to $30, the IPO would value the company at $14.7 billion. Based on metrics such as earnings and debt, that valuation would give HCA a “slight premium” to rivals such as Community Health Systems Inc. and Tenet Healthcare Corp., according to a Feb. 22 report from CreditSights Inc.

Community Health Systems, currently the biggest publicly traded hospital operator, in December bid $3.3 billion to buy Tenet in Dallas. If the takeover is successful, the combined company with about $22.2 billion in revenue as of Dec. 31, 2010 will still be smaller than HCA.

With as much as $4.28 billion in stock being sold, the HCA offering is poised to break the record set by Kinder Morgan Inc., the buyout-backed company that last month raised $2.9 billion in an IPO.

‘Medicare Schedule’

Shareholders will also have to weigh the impact of government spending cuts and changes to hospital payment schedules prompted by the 2010 U.S. health law and rules from the Centers for Medicare and Medicaid, which administer the federal programs.

Baltimore-based CMS has been pushing to bundle payments to doctors and hospitals, giving them a set amount for a procedure that has to be split among providers. The agency also plans to penalize providers if patients acquire infections while in treatment or fare badly after stays. Too many readmissions, once regarded as more revenue, may now result in lower payment rates.

The federal health-care law will extend health insurance to 32 million more Americans and may prompt some employers to drop company-sponsored health benefits in favor of sending employees to state insurance exchanges the new law creates. While the newly insured may mean less bad debt for hospitals, fewer private sector-paid benefits may mean lower revenue for for- profits like HCA, because commercial payers and employers tend to pay the highest rates to providers.

Health-Care Impact

“Hospitals are going to have to learn how to be productive and profitable on a Medicare rate schedule,” said R. Lawrence Van Horn, who teaches at the Owen Graduate School of Management at Vanderbilt University in Nashville. Medicare and Medicaid pay less for procedures and treatment than employers and commercial insurers, which are “traditionally the most generous payers,” he said.

HCA said in its filing that it can’t predict the impact of the changes on the company.

For-profit hospitals like HCA depend more on commercial payers and less on government beneficiaries than do nonprofits, which have already seen their revenue reduced by government cutbacks, particularly in Medicaid. Chains like HCA, with their access to capital, may be able to take advantage of weakness among nonprofits to consolidate the industry further, Van Horn said.

Megan Neuburger, an analyst at Fitch Ratings in New York, said the biggest impact of the health-care reform won’t be felt until 2014, and the market recovery will play a more important role for now in determining HCA’s success.

Returning Money

“In the short term, the pace and progress of economic recovery will probably be more influential to the industry’s financial and operating trends than health-care reform,” Neuburger said in an interview.

For KKR and Bain, the timing of the IPO is crucial also because their clients want to see whether buyouts made just before the credit crisis can be profitable, before they commit capital to new funds. KKR is seeking to raise its 11th North American-focused buyout fund this year.

Buyout firms have been able to return some money to investors through dividend recapitalizations, as near-zero interest rates have spurred a demand for junk bonds. Borrowers sold $47 billion of debt last year, or 9 percent of offerings, to pay owners, compared with $11.7 billion in 2008 and 2009, according to Standard & Poor’s Leveraged Commentary and Data.

‘Unprecedented Amount’

Investors in Bain’s 2006 fund have received $1.6 billion in distributions so far, or about 20 percent of the $8 billion deployed. HCA’s dividends recapitalizations accounted for about $302 million of the total Bain paid out to the fund’s clients, according to an investor in the fund. The fund has generated an average annual loss of 6.4 percent, according to another person familiar with the fund.

“Investors committed an unprecedented amount of money over a short time period,” said Jeremie Le Febvre, the Paris-based global head of origination for Triago, which helps private- equity firms raise money. “Investors most likely won’t be as generous a second time, or even have the means to double down on a firm, as reputable as it may be, without first seeing money flowing back into their pockets.”

–With assistance from Lee Spears in New York and Christian Baumgaertel in 東京. Editors: Christian Baumgaertel, Larry Edelman

Here is an article LA put together earlier last year on a possible IPO:

Check out our intensive investment banking, private equity, and sales & trading courses! The discount code Merger34299 will be activated until April 15, 2011. Questions? Feel free to e-mail thomas.r[at] with your inquiries or call our corporate line.

KKR Tries to Fool Investors with Toys R’ Us IPO

Wednesday, March 2nd, 2011

Toys R Us was an Opco-Propco deal done by KKR, Bain, and Vornado in 2005 for $6.5+ billion.  The company was one of the largest owners of real estate in the United States, other than McDonalds.  Since the toy business was not performing well and Babies R Us could not yet produce enough EBITDA to drive the company’s public valuation, these three players found an opportunity to take advantage of its real estate holdings (good call, right?).  Unfortunately, the company now has $5.5 billion in debt on its balance sheet and only has 2.3% growth in sales, a $35mm loss in earnings, down from $95mm in profit last year, and a 25% increase in expenses year over year (SA).  Cash used in operations also increased from $800mm to $1.2 billion over that time period.  Sounds like a great time to IPO, right?  Well, the sponsors in this deal seem to think so.  With equity markets topping, they are trying their hardest to take advantage of foolish retail investors.  Invest at your own risk:

“(Reuters) – Toys R Us Inc TOY.UL is looking to raise around $800 million in an initial public offering in April, though a final decision has not been reached, the New York Post said on Saturday.

The New Jersey-based retailer, which operates stores under its namesake brand and the Babies R Us and FAO Schwarz labels, had put off plans for an IPO in 2010.

“Toys R Us took more market share from competitors last year than they have in the past 20 years,” said one source the Post described as close to the company. “But I don’t think they were satisfied with how they did on the profit level.”

Toys R Us spokeswoman Kathleen Waugh said the company could not comment on the matter.

For December 2010, Toys R Us reported a 5.4 percent total sales rise at its U.S. unit as it lured holiday shoppers away from No. 1 toy retailer Wal-Mart with more temporary stores and exclusive toys. But same-store sales fell 5 percent at its international segment.

Overall, a tough 2010 holiday season had margins hit across the toy industry by bargain-seeking, recession-hit consumers.

So the economic environment has stoked continued debate between management and owners at Toys R Us about whether this is the best time to re-launch an IPO, according to a source briefed on the situation, the Post reported.

Toys R Us was taken private in 2005 by Kohlberg Kravis Roberts KKR.AS, Bain Capital and Vornado Realty Trust in a $6.6 billion deal.

In May 2010, the company filed to raise as much as $800 million in an IPO. But that was not launched.

Toys R Us’s net loss widened to $93 million in the third quarter ended on October 30, 2010, from $67 million a year earlier. While sales were up 1.9 percent in the period, total operating expenses rose about 9.4 percent.

Last fall, the retailer opened 600 smaller “pop-up” stores that added to the more than 850 larger year-round stores it operates in the United States, the Post said.”

LA Basic Leveraged Buyout Modeling Video Available for Only $99!

Friday, March 19th, 2010

As the job hunt continues, many students have asked for online learning materials. After about 150 hours of video editing, our team has put together a host of videos on modeling for mergers and buyouts.

Our pilot video, LA’s Basic Leveraged Buyout Modeling works through a full basic leveraged model and includes excel shortcuts. This is ideal for students who do not understand what -MIN functions are and how to create a 3 statement model in 30 minutes.

The LBO video is available for $129.99 on DVD and $99.99 online. Please e-mail for screen shots and a link to download and purchase.

Two excel templates will be included with purchase.

All purchases can be done in person or through Paypal.

Our Paypal ID is

A host of more complicated LBO modeling videos will be available shortly, including a model that will take more than 8 hours to complete.

300+ Finance Interview Questions by Jasmine

Saturday, March 13th, 2010


Finance Interview Questions

Background Questions
1.    Walk me through your resume. Tell me about yourself.
2.    What was the most important thing that you got out of your last or current job?
3.    Tell me about your previous work experience and walk me through a sample project from your work.
4.    What is the number one thing I should know about you that I cannot learn from your resume?
5.    Coming out of this interview, what are three things about you I should take away?
6.    How would your friends describe you? How would your professors describe you?
7.    Why did you choose to pursue your degree (MBA)?
8.    Why are you working in your current industry? Why did you choose the firm you are at now? Why did you choose your college? Do you regret choosing the school or job you chose?
9.    Tell me about your college experience.
10.    What was your favorite and least favorite course in school? Why? What were your grades in each?
11.    Have you had a performance review? What did it say?
a.    What would your last or current boss say about you?
12.    What types of activities did you pursue in college?
13.    What do you do in your free time? Tell me something interesting about you.
14.    What serves as your biggest motivation?
15.    What is the most recent book you’ve read?
16.    What separates you from other candidates? Why should we hire you?
17.    What are some of your strengths?
18.    Why this firm?  Be specific.
19.    What do you think is the most important characteristic for this job?
20.    What qualities do you feel that you have that are transferrable to this position?
21.    What are the qualities of a successful leader?
a.    Trustworthy, enthusiastic, confident, organized, tolerant, calm, focused, committed, and a great communicator. A good leader empowers others, allows group members to make decisions rather than micromanaging, and expresses appreciation for good work.
22.    Why do you think you will be good in this job?
23.    Why are you interested in finance, and do you have any experience in the field?
a.    Why hedge funds or private equity?
24.    What is a hedge fund?
a.    A hedge fund is a private investment partnership, which uses aggressive strategies unavailable to other types of funds. It is a loosely regulated investment pool that are open only to high net worth individuals since they are limited by law to 100 investors and thus typically require a minimum investment of $1 million. They liberally use financial techniques to hedge against risk with the goal of making a profit in any market environment, such as short-selling, swaps, risk arbitrage, and derivatives. Often these funds take on high risk and are highly leveraged to give their clients the potential for higher returns. They have much more latitude in the types of securities they can invest in because they are typically not restricted by most of regulations that other mutual funds must follow.
25.    Why are you applying here? What do you hope to gain from this job? What in particular is attractive about this firm?
26.    What do you know about our firm?
27.    What is the strategy of our fund?
28.    What three things would you change about this company? What direction would you take the firm if you were running it?
29.    If you had only three questions to ask senior management of a company, what would they be and why?
30.    What is your ideal work environment? What qualities would your ideal job have?
31.    Can ethical requirements in a firm be too high?
32.    If there were no such businesses as hedge funds/private equity, what would you do?
33.    What would you do for a living if you did not have to worry about money?
34.    Are you willing to travel or relocate for this position?
35.    What other types of jobs are you looking at? Only in hedge funds? Private Equity?
36.    Who else are you interviewing with and where are you in the process with other firms?
37.    What do you plan on doing in the next 10 years?
38.    Do you plan on going to business school? Why or why not?
39.    What aspect of finance do you find most interesting?
40.    If you have taken a finance course, present the most interesting topic you covered, and explain why you find that topic the most interesting.
41.    Provide a few different examples of careers in finance, and what exactly do they do? (i.e. investment bankers or investment managers)
a.    Investment bankers raise capital through debt or equity offerings for companies in the public or private marketplace. They also provide advice for companies on mergers and acquisitions and financial restructurings. They often do valuation work and pitch their bank’s expertise to potential client companies. At higher levels, investment bankers focus more on the clients and building relationships that can generate deal flow. At middle levels, bankers are more focused on executing the given service at a high quality to keep clients.
b.    Investment managers manage money for individuals and institutions.
42.    What is an institutional investor?
a.    An organization that pools together large sums of money and puts that money to use in other investments. Some examples are investment banks, insurance companies, retirement funds, pensions funds, hedge funds, and mutual funds. They act as specialized investors who invest on behalf of their clients.
43.    What are some recent trends in investment banking?
a.    Consolidation: banks being acquired by other banks. JPMorgan buying Bear Stearns, Barclays buying part of Lehman Brothers.
b.    Capital Infusions: Buffett investing in Goldman Sachs, Mitsubishi in Morgan Stanley, TARP
c.    Global Expansions: firms looking to expand into other, fast growing nations
d.    Technology: high technology is being used to execute trades and distribute information more quickly.
44.    What do you think you will be doing on a daily basis as an analyst?
a.    An analyst is responsible for financial modeling in Excel, comparable company analysis, precedent transaction analysis, preparing pitch books and PowerPoint presentations for clients, industry research, gathering of financial information. Long hours, and hopefully a chance for more responsibility if my work is good.
45.    Can you handle the grunt work?
46.    Imagine that you are hired, but a few months into the job you are fired. Provide three reasons why this may happen, and what you can do to prevent this.
a.    What are your weaknesses?
47.    What is your favorite web site?
48.    What recent article in the Wall Street Journal stands out to you most, and why?
49.    Do you read WSJ every day? What’s on today’s front page?
50.    What would you like for me to tell you? Do you have any questions for me?
a.    Financial:
i.    What is your opinion of where the economy is going in the next year?
ii.    Have you seen a change in deal flow due to the economic downturn?
iii.    In your opinion, what desks/product groups have the best reputation and/or the most promising future at this firm?
iv.    Do you think more investment banks will go under in the coming years?
v.    What do you see as the future of investment banking?
b.    Lifestyle
i.    How did you get into banking or this position?
ii.    Have you enjoyed your experience?
iii.    Have you worked at other firms, and how do your former experiences compare to this one?
iv.    What do you think separates this bank from similar banks?
v.    Culture-wise, what do you think is the biggest positive with this bank? The biggest negative?
vi.    What advice would give me going forward?
c.    Other
i.    What are the next steps in this process? When should I expect to hear from you?
Personal Examples and Behavior Questions
1.    How do you manage stress in your life?
2.    How do you arrange your priorities when time constrained? What would you place as most and least important?
3.    Provide an example of when you have had to pick between two priorities, and how you chose between the two? (i.e. attending a last minute meeting over attending an event you previously committed too)
4.    Provide an example of a time where you had to handle many things at once or multitask.
5.    Provide an example of a time you had to make a split second decision.
6.    Provide an example of a time where you anticipated potential problems and took measures to prevent them.
7.    Provide an example of a time where you learned something new in a short amount of time.
8.    Describe a situation when you or your group was at risk of missing a deadline, what did you do?
9.    Provide an example of a time where you set a goal and were able to meet or achieve it.
10.    What is the biggest risk you have taken in your life?
11.    What is the biggest obstacle or challenge you have faced and overcome in your life?
12.    Provide an example of a time where you failed and turned it into a learning experience.
13.    What is the biggest mistake you have made in your professional life?
14.    What do you consider to be your greatest failure?
15.    What is the toughest decision you have ever had to make?
16.    What is the most difficult experience you have had? Why? How did you approach it and how would you have done things differently?
17.    Provide an example of your greatest accomplishment or an accomplishment you are proud of.
18.    What role do you like to take in a team situation?
19.    Do you feel more comfortable working in a group or individually?
20.    Provide an example of a situation where you worked with a team. Provide an example of a time you took a leadership role in a team situation.
21.    Provide an example of a time you had to deal with conflict in a team situation.
22.    Provide an example when you had to deal with an upset teammate or co-worker?
23.    Provide an example when you were in a group where someone was not contributing as they should have been. What did you do?
24.    Provide an example of a project you have completed that you particularly enjoyed.
25.    How do you manage dealing with a difficult boss, co-worker, or teammate?
26.    Provide an example of a time where you successfully persuaded others to do something or see your point of view.
27.    Provide an example of a time you had to motivate others.
28.    Provide an example of a time you went above and beyond expectations.
29.    Provide an example of a time when you were required to pay close attention to detail.
30.    Provide an example of a situation where that involved heavy analytical or quantitative thinking.
31.    How have you modeled with equations in the past?
32.    Provide an example of an experience of failure or when you failed to meet expectations.
33.    You do not seem very driven. How will you be able to handle this position?
34.    How did you go about preparing for this interview?
Knowledge and Technical Questions
1.    Explain what happened with the mortgage crisis?
a.    Mortgage market in America created a financial crisis. Interest rates were very low, and lenders allowing people to borrow large amounts with low credit ratings. Loans were granted with teaser rates, no down payments, and no review of a borrower’s income history. Many mortgages were adjustable rate mortgages that begin with affordable payment but increase the rate later on. Borrowers with less than stellar credit ratings, called subprime borrowers, were taking out loans that they really could not afford. Due to these loans, demand for houses increased and home value increased creating a housing bubble from 2000 to 2005. In 2006, the bubble burst and total home equity dropped from $13 trillion to $8.8 trillion. By January 2009, 20% of US homes were underwater since the owner owed more on their mortgage then their home was worth. When more homeowners found themselves underwater, they had no incentive to continue paying mortgages so walked away from home. When homeowner foreclosed upon or walks way, stop paying mortgage payments, decreasing the value of MBS that were on the balance sheets as assets of many banks and had to be written down due to the declining value causing banks to incur loss. As capital and asset base declines, they restricted lending to meet reserve requirements and preserve liquidity.
b.    Increasing the severity of the problem, banks making these loans were selling off the future mortgage payments to other banks. They repackaged them and sold them as Mortgage Based Securities.
c.    Combination of these features led to a cycle which is largely the catalyst of the recession were currently in. (housing prices declinenegative equityhomeowners walk awayincreased supply of houses) (when homeowners walk awaymortgage payments declinevalue of mortgage backed securities declinesbanks incur lossesbank capital declinesbanks restrict lendingeconomic activity slows and unemployment increases) Because supply of houses increased, housing prices declined further, and cycle started over.
2.    What is a mortgage backed security?
a.    A class of asset-backed security that pays its holder periodic payments based on cash flows from underlying mortgages that fund the security. MBS market allowed investors to lend money to homeowners with banks as middlemen with investor purchasing MBS and paid back over time by payments from homeowners.
b.    Many MBS rated AAA because considered highly diversified and not though that housing market would collapse across the board. Now we know housing values highly correlated and AAA rating too optimistic.
3.    What is collateralized debt obligation?
a.    Broad asset class in which a number of interest paying assets are packaged together, securitized, and sold in the form of bonds
b.    A type of security that pools together a number of interest paying assets, and pays coupon payments based on those assets future cash flows.
c.    Investor pays market value for CDO and then has right to interest payments in form of coupon payments over time.
4.    What is a credit default swap?
a.    Insurance on a company’s debt and is a way to insure that an investor will not be hurt in the event of a default. Sold over the counter in an unregulated market. The credit default swap market is estimated at $62 trillion. If you own the bond of a company and purchase a CDS of that bond, and the company defaults, then the party that sold you the CDS is responsible for paying you a certain amount of what you lost because of the default.
b.    CDS buyer promised to pay seller annual payments, receive large payout if underlying company defaults, swap will become more valuable if underlying company becomes financially distressed
c.    CDS seller promises to pay swap buyer certain a mount if underlying company defaults, receives annual payments in exchange for the insurance; sellers include investment banks, hedge funds, insurance companies, etc.
d.    Can be used for hedging (as an insurance policy against bond defaulting) or speculating (purchase the swap with the thought that the bond will become distressed, and more investors will desire the insurance, raising the value of the swap which can be sold).
5.    What is securitization?
a.    When an issuer bundles together a group of assets and creates a new financial instrument by combining those assets and reselling them in different tiers called tranches. One of the reasons for the recession has been the mortgage backed securities market, which is made up of a securitized pool of mortgages banks issued and then sell off the future cash flows, mortgage payments, from those mortgages to another investor.
6.    What are the three main financial statements?
a.    The Income Statement, Balance Sheet, and Statement of Cash Flows.
7.    What is the difference between the Income Statement and Cash Flow Statement?
a.    The Income Statement records revenues and expenses, while the cash flow statement has the following categories: operating cash flows, investing cash flows, and finance cash flows. It records what cash is actually being used and where it is being spent by the company during that time period. A company can be profitable as seen by the Income Statement, but still go bankrupt if it doesn’t have enough cash flow to make interest payments.
8.    Walk me through the lines on the Cash Flow Statement? Income Statement?
a.    Beginning cash balance, then cash from operations, then cash from investing activities, then cash from financing activities, and the ending cash balance.
b.    Revenues-COGS=Gross Margin-Operating Expenses=Operating Income-Other Expenses-Income Taxes=Net Income
9.    What are the components of each of the items on the Cash Flows Statement?
a.    Operations is cash generated from the normal operations of the company. Investing is change in cash from activities outside normal scope of the business, including purchases of property and equipment, and other investments not reflected on the income statement. Financing is cash from changes in liabilities and stockholder’s equity including any dividends paid out, issuance of any debt or equity, or the repurchase of debt or equity.
10.    How are the three financial statements connected?
a.    Income Statement: Net income minus dividends is added to Retained Earnings under shareholder’s equity on the Balance Sheet. Net income is added to cash flows from operations on CF statement after making adjustments for non-cash items.
b.    Balance Sheet: Interest expense is calculated from the long term debt under liabilities. Depreciation expense on Income Statement and Cash Flow Statement is calculated based on property and equipment.
c.    CF Statement: starts with beginning cash balance from Balance sheet. After making adjustments to Net income, the cash flow form operations, investing, and financing, calculate the ending cash balance, which become current period’s balance sheet cash. Cash from operations is derived from changed in Balance sheet accounts, and is impacted by the change in net working capital (CA-CL). Any change in property due to purchase or sale of that equipment affects cash from investing.
11.    From the three financial statements, if you had to choose two, which would you and why? If you had to choose one, which would it be?
a.    The Balance Sheet and Income Statement can be used to make the St of Cash Flows.
b.    Not IS, because full of non-cash items. CFS because cash is king in determining a company’s health. Or BS because you can back out the main components of the cash flow statement (capex via PP&E and depreciation, net income via retained earnings, etc). The BS is helpful in distressed situations to determine the company’s liquidation values.
12.    What happens to each of the three primary financial statements when you change a) gross margin, b) capital expenditures, c) depreciation expense?
a.    Gross margin is gross profit/sales= total sales- cost of goods sold. If it decreases, then gross profit decreases relative to sales. Less income tax and lower net income if nothing else changed on the Income Statement. On the Statement of Cash Flows, have less cash. On Balance Sheet, less cash and thus less shareholder’s equity.
b.    Capital expenditures decrease. On CF St, Capital expenditures would decrease and thus increase cash, increasing cash on Balance Sheet but decreasing level of Property and Equipment so total assets remain constant. On the income statement, depreciation expense would be lower, so net income would be higher, which would increase income tax, cash, and shareholder’s equity in the future.
c.    Increase in Depreciation. Lower operating profit and thus pay less taxes and decrease net income. On Cash Flows St: Reduction of net income reduces cash from operations, but increases cash from operations since depreciation is non-cash expense thus increasing ending cash. Balance sheet: cash increases, PP&E decrease, overall assets fall, retained earnings fall due to drop in net income.
13.    If you sold an asset and received $200 million in cash. How would it affect your three main financial statements?
a.    Ask for book value of the asset. If book asset is $100 mil, then $100 gain on sale of asset is recorded, so net income increases by $60 mil if assume 40% tax rate. On CFS, assets are recorded at book value when sold, so have $100 mil under cash from investing activities. Net cash flow is $160 mil. On the BS, cash increases by $160, and property decreases by $100 mil. Balance by increasing shareholder’s equity by $60 mil.
14.    An item cost $10 to buy, and has a life of ten years. How would you put it on the balance sheet?
a.    On the left side, $10 as an asset. Assuming straight line depreciation for book and no salvage value at the end of its useful life, it would be worth $9 at the end of the first year. Net income will be lowered every year by the tax-affected depreciation, so shareholder’s equity will be reduced by 60 cents assuming a 40% tax rate.
15.    If you later discover the item is a valuable collector’s item, how much would it be on the balance sheet now?
a.    Still $8, since you continue to depreciate it and assets are recorded at historical values. Some traded financial instruments qualify for “mark to market accounting”, so these assets are valued at market.
16.    If after the second year, the pen runs out of ink and is thrown away, how much is it on the balance sheet?
a.    Write down the value of the equipment to $0. Due to the write down, net income declines by $4.8 based on 40% tax rate, which flows to shareholder’s equity. On the CFS, it is added to the $4.8 decline in net income since the $8 write-down is non-cash, resulting in a net cash flow of $3.2. Combined with the write-down in property, net change in assets is a decrease of $4.8, which balances the decrease in shareholder’s equity.
17.     What is a 10-K?
a.    A report similar to the annual report, except it contains more detailed information about the company’s business, finances, and management. It also includes the bylaws of the company, other legal documents and information about any lawsuits in which the company is involved. All publicly traded companies are required to file an annual 10-K to the SEC.
18.    What is Sarbanes-Oxley and what are the implications?
a.    A bill passed by Congress in 2002 in response to accounting scandals. To reduce the likelihood of accounting scandals, the law established new standards for publicly held companies. Those in favor of this law believe it will restore investor confidence by increasing corporate accounting controls. Those opposed to this law believe it will hinder organizations that do not have a surplus of funds to spend on adhering to the new accounting policies.
19.    What should a company do with excess cash on the balance sheet?
a.    There is an opportunity cost to holding too much cash by giving up potential earnings from investing that cash elsewhere. A company should have enough cash to protect itself from bankruptcy, but above that level cash should be either: reinvested into the firm, paid out in the form of dividend to equity holders, or used to pay off debt, repurchase equity, expand to new markets or buy out a competitor, supplier, or distributor. Growing companies tend to reinvest rather than pay dividends.
20.    If a company has seasonal working capital, is that a deal killer?
a.    Working capital= current assets-current liabilities. Seasonal working capital applies to firms whose business is tied to certain time periods. When current assets are higher than current liabilities, more cash is being tied up instead of being borrowed. In a season when demand is higher, the firm must build up inventories to meet this demand at this time, increasing current assets which increases liquidity risk, so if the product is not purchased the company is stuck holding the inventory. Also, if the company cant collect owed cash from AR in time to pay creditors, it runs risk of bankruptcy. This is an issue, but not a deal killer if the company has an adequate revolver and can predict the seasonal WC requirements with some clarity. Generally, any recurring event is fine as long as it continues to perform as planned. A massive surprise event is what kills an investment.
21.    A product’s life cycle is now mature. What happens to the working capital?
a.    The net working capital needs should decrease as the business matures, which increases cash flows. As the business develops, it becomes more efficient and invest requirements are lower.
22.    What is goodwill and how does it affect net income?
a.    Goodwill is an intangible asset on the balance sheet that includes brand name, good customer relations, and intellectual property. It is often created in an acquisition, which represents the value between price paid and the company’s book value acquired. If an event occurs that diminishes the value of goodwill (patent running out, or event hurting brand name), it is written down and is then subtracted as a non-cash expense thus reducing net income.
23.    Is goodwill depreciated?
a.    Not anymore. Accounting rules now state that goodwill must be tested once per year for impairment. Otherwise, it remains on the BS at its historical value.
24.    What is PIK?
a.    PIK stands for paid in kind, an important non-cash item that refers to interest or dividends paid by issuing more of the security instead of cash. It can be toggled on at a particular time, often times at the option of the issuer. It becomes popular with PE firms, who could pay more aggressive prices by assuming more debt. Flipping on PIK may be an indicator that the company is nearing default on interest payments due to lack of cash because of a deteriorating business. PIK can dramatically increase the debt burden on the company at a time when it is already showing signs of difficulty with the existing levels.
25.    If a company issues a PIK security, what impact will that have on the three financial statements?
a.    This can mean compounding profits for the lenders and flexibility for the borrower. If a mezzanine bond of $100 mil and 10% PIK interest is issued, it is added to the BS as $100 mil of debt and cash. On the CFS, cash flow from financing increases by $100 mil. When PIK is triggered, interest on the IS is increased by $10 mil, which reduced net income. This carries over onto CFS due to the net lower net income, but PIK interest is added back since it is non-cash, thus resulting in a positive cash flow which thus increases cash on the BS and debt increases, causing shareholder’s equity to decrease.
26.    What is a PIPE?
a.    With the cost of credit rising, “private investments in public equity” are more popular through providing an alternative way for companies to raise capital. They are made by qualified investors (HF, PE, mutual funds) who purchase stock in a company at a discount to the current market value. The financing structure become prevalent due to the relative cheapness and efficiency in time versus a traditional secondary offering. There are less regulatory requirements. The most visible PIPE transaction of 2008: Bank of America’s $2 billion investment in convertible preferreds of mortgage lender Countrywide Financial.
27.    If you put $100 in the bank and got back $2 every year for 5 years and then in the 6th year, received $102, what is your IRR?
a.    2%. The duration of the investment doesn’t matter.
28.    What is the difference between IRR, NPV, and payback?
a.    IRR measures the return per year on a given project and is the discount rate that makes NPV=0. NPV measures whether or not a project can add additional or equal value to the firm based on its associated costs. Payback measures the amount of time it takes for a firm to recoup the initial costs of a project without taking into account the time value of money.
29.    What is a coverage ratio? What is a leverage ratio?
a.    Coverage ratios determine how much cash a company has to pay its existing interest payments. The formula: EBITDA/interest.
b.    Leverage rations are used to determine the leverage, or the relation of a firm’s debt to its cash flow generation. There are many forms: debt/EBITDA or debt/Equity which measures the relation of debt to equity that a company is using to finance its operations.
30.    If I increase AR by $5 million, what effect does that have on cash?
a.    No immediate effect on cash. AR means that cash will be received for the product or service at a later point in time. There will be an increase in cash of $10 mil when the company collects on the AR.
31.    Give examples of ways companies can manipulate earnings.
a.    Switching from LIFO to FIFO. In a rising cost environment, FIFO will show lower earnings, higher costs, and lower taxes.
b.    Switching from fair value to cash flow hedges. Changes in fair value hedges are in earnings, changes in cash flow hedges are in other comprehensive income. Having negative fair value hedges and then shifting them to cash flow hedges will increase earnings.
c.    Taking write-downs to inventory will decrease earnings.
d.    Changing depreciation methods
e.    Having a more aggressive revenue recognition policy. Accounts receivable will increase rapidly because they’re extending easier credit.
f.    Capitalizing interest that shouldn’t be capitalized, so you decrease interest expense on the income statement
g.    Manipulating pre-tax or after-tax gains
h.    Mark-to-market/mark-to-model
32.    What is enterprise value?
a.    The value of an entire firm to both debt and equity holders.
b.    Enterprise value= market value of equity (market cap) + debt + value of outstanding preferred stock + value of minority interest the company has – cash the company currently holds.
33.    If enterprise value is 150, and equity value is 100, what is net debt?
a.    Net debt is 50.
34.    Why do you subtract cash from enterprise value?
a.    Cash is already accounted for within the market value of equity. Also, subtract cash because can either use that cash to pay off some of the debt, or pay yourself a dividend, effectively reducing the purchase price of the company.
35.    What is EBITDA?
a.    Earnings before interest, taxes, depreciation, and amortization. A proxy for cash flow, metric to evaluate a company’s profitability and financial performance. Good way of comparing the performance of different companies because it removes the effects of financing and accounting decisions like interest and depreciation, and is also considered a rough estimate of free cash flow.
b.    EBITDA= Revenues-Expenses (excluding T,D,A)
36.    You have a company with $50 million in sales. Which makes the biggest impact? Volume increases by 20%, price increases by 20%, expenses decrease by $15 million?
a.    Price by 20% if you consider how EBITDA is affected. Price has a bigger cost impact than expenses. Volume will increase revenue but variable costs will increase proportionally.
37.    If a company’s revenue grows by 15%, would its EBITDA grow by more than, less than, or the same percent?
a.    Unless there are no fixed costs, EBITDA will grow more, because fixed costs stay the same so total costs will not increase as much as revenue.
38.    Given that there is no multiple expansion and flat EBITDA, how can you still generate a return?
a.    Reduce interest expense, improve tax rate, depreciation tax shield, the simple act of leverage, pay down debt, pay a dividend, reduce capes, reduce working capital requirements and reduce change in other.
39.    What are different multiples that can be used to value a company?
a.    Price to Earnings multiple (P/E Ratio), EBITDA, EV/EBIT, EV/Sales and book value or Price/Book. Different multiples may be more or less appropriate for specific industry. The relevant multiple depends on the industry. Internet companies are valued with revenue multiples, which is why companies with low profits have high market caps. Companies in the metal and mining industry are valued using EBITDA.
40.    Why do P/E and EBITDA multiples yield different valuation results?
a.    EBITDA multiples represent the value to all stakeholders (debt and equity), while the P/E ratios only represent the value to all equity holders. EBITDA multiples are often used to value firms that have negative income, but positive EBITDA. They do not factor in the effect of interest and thus allow for comparability across firms regardless of capital structure. You will never see EV/Earnings or Price/EBITDA ratios, since the numerator and denominator must correspond to the same set of stakeholders.
41.    Which industries interest you? What are the P/E multiples for these industries?
42.    Is 15 a high P/E ratio?
a.    It depends. P/E ratios represent how many dollars an investor is willing to pay for one dollar of earnings. It is a relative measurement and to determine if it is high you need to know the general P/E ratio of comparable companies. High growth firms usually have higher P/E ratios, since they have high anticipated growth in earnings and thus their earnings are low relative to price with the assumption that the earnings will eventually grow more rapidly than the stock’s price. Thus, if 15 in high growth tech industry, then relatively low.
43.    Why are the P/E multiples for an international company, say in Europe, different than a United States company?
a.    The P/E multiples can be different even if all other factors are constant because of the difference in the way earnings are recorded. Market valuations in American markets tend to be higher than in the UK.
44.    What does spreading comps mean?
a.    Task of collecting and calculating relevant multiples for comparable companies and summarizing them for easy analysis or comparison.
45.    What is valuation?
a.    Procedure of calculating the worth of an asset, security, company, etc.
b.    One of the primary tasks investment bankers do for clients. Value their company or value a company they are thinking about purchasing or divesting.
46.    Given a company’s income, how would you find its free cash flow?
a.    Net Income + Depreciation and Amortization – Capital Expenditures (how much cash company invests in plant and equipment each year) – change in net working capital = Free Cash Flow (FCF)
47.    How do you calculate free cash flow to equity?
a.    To equity (levered cash flow): Same as firm FCF and then subtract interest and any required debt amortization.
48.    What is net working capital?
a.    Net working capital=current assets- current liabilities
b.    It is a measure of how able a company is to pay off its short term liabilities with its short term assets. If the number is negative, the company may run into trouble paying off creditors which could result in bankruptcy if cash reserves are low enough.
49.    What happens to free cash flow if net working capital increases?
a.    Net working capital is the net dollars tied up to run the business. As more cash is tied up, there is less cash flow generated. Since subtract change in net working capital in calculation of free cash flow, if net working capital increases then free cash flow decreases.
50.    What are the basic ways to value a company?
a.    Comparable Companies (to calculate either enterprise value or equity value), how other similar companies were valued recently as multiple
i.    Average multiple from comparable companies multiplied by the operating metric of the company valuing
ii.    Most common multiple is enterprise value/EBITDA
iii.    Ex: if comparable company trading at EV/EBITDA multiple of 6.0x, and the company you are valuing has EBITDA of $100 mil, EV would be $600 mil based on this valuation method
b.    Market Valuation/Market Capitalization
i.    Market value of equity is only for publicly traded companies.
ii.    Market cap= number of shares outstanding x current share price
iii.    Market cap of company+ net debt on its books to get total enterprise value
c.    Precedent Transactions
i.    Find historical transactions similar to this transaction. Once identified comparable transactions, look at how those companies were valued. What were the EV/EBITDA and EV/Sales multiples paid? Calculate variation multiple based on the sale prices in those transactions and apply the multiple to the appropriate metric of the company being valued. This will often result in highest valuation due to inclusion of control premium that a company will pay for assumed synergies that they hope will occur after purchase.
d.    Discounted Cash Flow Analysis
i.    Project free cash flows for a period of time (5 years). Next, predict the free cash flows for the years beyond 5 years though using a terminal value multiple or using the perpetuity method. To calculate perpetuity, establish a terminal growth rate which is usually around the rate of inflation or GDP growth. Then multiply the final, or year 5, cash flow by 1 plus the growth rate and divide it by your discount rate minus the growth rate. To do this, you must establish a discount rate using WACC (Question 46), and discount all your cash flows back to year 0 using that discount rate. The sum of the present values of all those cash flows is the value of the firm.
e.    LBO Valuation
i.    Leveraged buyout is when a firm uses a higher than normal amount of debt to fiancé the purchase of a company, then uses the cash flows from the company to pay off the debt over time. Often use the assets of the company being acquired as collateral for the loan. When sell company, ideally the debt has been partially or fully paid off, and they can collect most of the profits from the sale as the sole equity owners of the company. Since a smaller equity check was needed up front due to higher level of debt used to purchase the company, this can result in higher returns to the original investors than if had paid for company with all own equity.
51.    Why do you project out free cash flows for the DCF model?
a.    Because FCF is the amount of actual cash that could hypothetically be paid out to lenders and investors from the earnings of a company.
52.    How would an increase in depreciation in year 4 affect the DCF valuation of a company?
a.    Decreases net income, but add back depreciation in calculation of free cash flow, so FCF increases and valuation increase and valuation will increase by the present value of that increase.
b.    PV of increase in yr 4= increase amount/ (1+WACC)^4
53.    Why might there be multiple valuations of a single company?
a.    Since there are several different methods of valuation, each yields a different valuation due to different assumption, different multiples, or different comparable companies or transactions. The two main methods, WACC and APV, make different assumptions about interest tax shields which leads to different valuations.
54.    Of the valuation methodologies, which are likely to have a higher/lower value?
a.    Of the four main valuation techniques (market value, market comps, precedent transactions and DCF), the highest valuation will normally come form the Precedent Transactions technique because a company will pay a premium for the synergies coming from the merger. DCF will usually give next highest because those building DCF tend to be optimistic in assumptions and projections going into their model. Market comps and market values will give lowest valuation. Market comps is based on other similar companies and how they are trading in the market, so no control premium or synergies. Market valuation is based on how the target is being valued by the market, and is just equity value no premiums or synergies. LBO is lower than DCF, as it’s discounted at a higher cost of equity.
55.    What is the risk free rate?
a.    The risk-free rate is the current yield on the government Treasury bond for the period for which the projections are being considered.  The ten year treasury is often used. It is considered risk-free since the US government is considered to be a risk-free borrower.
56.    What is beta?
a.    A measure of relative volatility or risk of a given investment with respect to the market. If Beta is 1, the returns on the investment vary identically with the market’s returns. B<1: less volatile than market (lower risk, lower reward), and vice versa. The market refers to a diversified index such as the S&P 500.
57.    How/why do you lever/un-lever a company’s beta?
a.    Levered beta will be the beta found on websites like yahoo finance.
i.    Bl=Bu(1+(1-T)(D/E))
b.    By un-levering beta, you are removing the financial effects from leverage (debt in the capital structure), which thus shows you how much risk a firm’s equity has compared to the market, or how much risk investors are taking by investing in a company’s equity or stock. So you calculate the Beta under the assumption it is all-equity firm.
i.    Bu=Bl/(1+(1-T)(D/E))
c.    When a company doesn’t have a beta, you can find a comparable company beta and un-lever it then re-lever it using capital structure to come up with beta. To un-lever a company’s Beta, calculate the Beta under the assumption that it is an all-equity firm.
58.    How would you calculate an equity beta?
a.    Perform a regression of the return of the stock versus the return of the market as a whole. The slope of the regression line is beta.
59.    What kind of an investment has a negative beta?
a.    Gold. When the stock market goes up, the price of gold drops as people leave the safe haven of gold. Opposite occurs when the market goes down, implying a negative correlation.
60.    What is the formula for the Capital Asset Pricing Model?
a.    CAPM is used to calculate the expected return on an investment (ROE), or the cost of equity of a company. Beta for a company is measure of the relative volatility of the given investment with respect to the market.
b.    The formula is: Discount rate for leveraged equity=risk-free rate + Leveraged beta (excess market return)
61.    How do you get the discount rate for an all-equity firm?
a.    You use CAPM to calculate the cost of equity and that would be the discount rate.
62.    Can you apply CAPM in international markets?
a.    CAPM was developed for U.S. markets, but is presently the best known tool for calculating discount rates so it is a good framework for analyzing discount rates outside of the US as markets are based on similar principles.
63.    How do you calculate a company’s terminal value?
a.    2 Ways:
b.    Terminal multiple method: Choose operation metric (EBITDA) and apply a comparable company’s multiple to that number from the final year of projections, and discounting that back to the present. This method is less dependent on the assumed growth rate.
c.    Perpetuity Growth method: choose a modest growth rate, usually just a bit higher than inflation rate or GDP growth rate, in order to assume that the company can grow at this rate infinitely or assume perpetually stable growth after that year. Then multiple FCF from final year by 1 plus the growth race and divide by the discount rate (WACC) minus the assumed growth rate.
i.    =Final year FCF(1+g)/(WACC-g)
ii.    Formula comes up with the value in that year based on future cash flows, and discounting that value back to the present day.
64.    What is WACC and how do you calculate it?
a.    Weighted Average Cost of Capital is the discount rate used in DCF analysis to present value the company’s cash flows and terminal value and reflects the risk of that company. It represents the blended cost to both debt and equity holders of a firm based on the cost of debt and cost of equity for that specific firm.
b.    WACC = [(% Equity) * (Cost of Equity)] + [(% Debt) * (Cost of Debt)(1-tax rate)]
c.    Cost of equity is calculated using CAPM
65.    What is the difference between APV and WACC?
a.    WACC incorporates the effect of tax shields in the discount rate used to calculate the present value of cash flows. It is typically calculated using actual data and numbers from balance sheets and uses consistent capital structure over the period of valuation.
b.    APV adds present value of financing effects (commonly the debt tax shield) to net present value assuming an all-equity value, and calculates the adjusted present value. The APV approach is useful in cases where subsidized costs of financing are more complex and if capital structure is changing, such as leveraged buyout.
66.    Why do companies like Facebook and Twitter receive billion dollar valuations when they have very low revenue and profit margins?
a.    Investors are anticipating extremely high future earnings of these businesses due to their reach and growth trajectory and are less focused on present revenues and margins. They believe that these sites will tap into the earning power of their millions of users in a way they aren’t currently doing.
b.    Ex: Facebook, social media giant, inventors banking on the fact that the company will find a better way to monetize their massive user base of over 200 mil members either through finding a better way to charge higher rates for advertising, their earnings will be large. Also, another reason is that companies like Microsoft are willing to pay large premiums for a small equity stake in the business in order to try and catch the wave of the future and establish a close partnership. In 2007, Microsoft invested in Facebook at a valuation of $15 billion.
67.    Name three companies that are undervalued, and why you think this? How about three that are overvalued?
a.    Example: If a company receives bad PR and its stock went down, but the earnings are not expected to decrease significantly due to the negative publicity, then it is trading at a lower P/E relative to others in the industry so it is undervalued.
68.    How much would you pay for a company with $30 million in revenue and $6 million in profit?
a.    Use the comparable transaction or multiples method to value the company rather than DCF. To use the multiples method, examine common stock information of comparable companies in the same industry, to get average industry multiples of Price to earnings. Then apply that multiple to find this company’s value.
69.    How do you value a company with no revenue?
a.    Make assumptions about the company’s projected revenues and cash flows for future years, then do a discounted cash flow model to calculate Net Present Value of these cash flows using an appropriate discount rate.
70.    What is operating leverage?
a.    The percentage of costs that are fixed versus variable. If costs are mostly fixed, company has high level of operating leverage.
71.    A company has $5 million of cash and $1 million of shares, nothing else. What’s its stock price?
a.    Stock price= value/shares so 5/1, which is a stock at $5 per share
72.    What if the company wins $5 million in the lottery?
a.    The company doubled in cash and thus its value, so now $10 per share.
73.    How do you think about the credit metric: (IBITDA- Capex)/Interest expense?
a.    How many times a company can cover its interest burden while still being able to reinvest into the company.
74.    Of the four debt covenants (minimum EBITDA, maximum capex, minimum interest coverage, maximum leverage), which one is the most important?
a.    Minimum EBITDA because EBITDA is the basis of valuation, and if the company can’t make its EBITDA covenant, it’s a signal that there might be something operationally wrong with the company. A company can sell assets to pay down debt and reduce interest expense, but that will not solve underlying business problems.
75.    What is the difference between bank loan and high-yield debt covenants?
a.    Bank loans are stricter in terms of maintenance covenants. For looser covenants, high-yield debt is rewarded with higher interest rates. Covenants can restrict economic activities, finance activities, or accounting measurements. Economic activities restricted would include the sale of assets, capex, changes in corporate structure. Finance activities restricted could include issuance of additional debt and payment of cash dividends. Covenants often track accounting measurements, such as interest coverage, current ratios, minimum EBITDA.
76.    What determined your split between bonds and bank in the deal? If there is a higher growth capex proportion of total capex, would you still want to use same split?
a.    Usually prefer bank debt because it’s cheaper than bonds. However, this depends on bank willingness to grant loan. The sponsor and debt holders have to negotiate agreements/covenants that they can live with. The more senior the debt, like the bank debt, the more restrictive it tends to be. Bank debt usually requires collateral to be pledge. The timeline of debt payback needs to be evaluated; bank debt usually has a shorter maturity, so the bank needs to ensure that the company will be able to face its liabilities when due or else face bankruptcy. Growth capes is more favorable than maintenance capex. It’s flexible; maintenance capex needs to be paid every year just to keep the company running, whereas growth capex can be stalled in times of downturn. Growth capex implies investments, which yield higher cash flows in the future, than can be used to support more debt.
77.    Given negative news about a company, what happens to the pricing of the equity versus the senior debt?
a.    Since equity is riskier and there is more uncertainty associated with it, the equity will be more volatile and decline in price by a greater percentage than the debt.
78.    What is a stock purchase and what is an asset purchase?
a.    A stock purchase refers to the purchase of an entire company so that all the outstanding stock is transferred to the buyer. Effectively, the buyer takes the seller’s lace as the owner of the business and will assume all assets and liabilities. In an asset deal, the seller retains ownership of the stock while the buyer uses a new or different entity to assume ownership over specified assets.
79.    Which structure does the seller prefer and why? What about the buyer?
a.    A stock deal generally favors the seller because of the tax advantage. An asset deal for a corporation causes the seller to be double-taxed; at the corporate level when the assets are sold and at the individual level when proceeds are distributed to the shareholders. In contrast, a stock deal avoids the second tax because proceeds transfer directly to the seller. In non-C corporations like LLCs and partnerships, a stock purchase can help the seller pay transaction taxes at a lower capital gains rate. Since a stock purchase transfers the entire entity, it allows the seller to completely extract itself from the business.
b.    A buyer prefers an asset deal, because it can pick and choose which assets and liabilities to assume, decreasing the amount of due diligence needed. Second, the buyer can write up the value of the assets purchased- a step-up in basis to fair market value over the historical carrying cost, which can create an additional depreciation write-off, becoming a tax benefit.
80.    Why should the fair market value of a company be the higher of its liquidation value and its going-concern value?
a.    Liquidation value is the amount of money that could quickly be sold immediately, usually at a discount. The fair market value, the rightful value at which the assets should be sold, is higher. A liquidation value implies the buyer of the assets has more negotiating power than the seller, while fair market values assumes a compromise. The going-concern value is the firm’s value as an operating business to a potential buyer, so the excess of going-concern value over liquidation value is booked as goodwill in acquisition accounting. If positive goodwill exists, the company has intangible benefits that allow it to earn better profits than another company with the same assets; the going-concern value should be higher than the fair market value.
81.    How will a decrease in financial leverage affect a company’s cost of equity capital?
a.    A decrease in financial leverage lowers the beta which lowers the cost of equity capital. With less debt, the firm is at a reduced risk of defaulting, and causes equity investors to expect a lower premium for their investments and therefore reduce the cost of equity.
82.    Would you rather have an extra dollar of debt pay-down or an extra dollar of EBITDA?
a.    An extra dollar of EBITDA because of the multiplier effect. At exit, the EV is dependant on the EBITDA times the exit multiple. An extra dollar of debt pay-down increases your equity value by only $1; an extra dollar of EBITDA is multiplied by the exit multiple, which results in a greater value creation.
83.    Given $75 million initial equity investment, 5 years, IRR of 25%, what’s exit EBITDA if sold at 10x multiple.
a.    Knowing an IRR of 25% over 5 year is approximately 3.0x equity return (no mathematic way of knowing this, so ask interviewer if don’t know). The ending equity value is thus 3x*75 million=$225 million, so the exit EBITDA must be $225/10x=$22.5 million.
84.    Describe a typical company’s capital structure?
i.    Capital structure is the structure of capital that makes up the firm, or its levels of debt and equity. Debt can be broken down into senior, mezzanine, and subordinate with senior paid off first then mezzanine then subordinate. Since senior is paid off first it has a lower interest rate. Equity is broken down into preferred and common stock. Preferred stock is a combination of debt and equity in that it has the opportunity for some appreciation in stock but pays a constant dividend that is not tied to the market price of the stock. Common stock is traded on the exchanged. In event of bankruptcy, debt has first priority, while common stockholders have the last right to assets in the event of liquidation and thus bear the highest level of risk and the highest return on their investment.
85.    What are you assuming when you short the junior piece of a capital structure and long the senior piece?
a.    You are assuming your return will make up the negative carry you will have to pay due to the higher interest rate on the junior piece of debt.
86.    Why is bank debt maturity shorter than subordinated debt maturity?
a.    Bank debt will usually be cheaper (lower interest rate) because of its seniority, since it is less risky and needs to be paid back before debt tranches below it. To make it less risky to lenders, a shorter maturity helps, usually less than 10 years. Bank deposits tend to have shorter maturities, so this aligns the cash flows of the bank business.
87.    What is your investing strategy?
88.    What are your long and short ideas?
89.    Where do you think the stock market will be in 6 months?
90.    What happened in the markets during the past three months?
91.    What stocks do you own? What three stocks would you invest in?
92.    What did the S&P 500 close at yesterday?
93.    Where do you think the Dow Jones Industrial Average will be in 6 months?
94.    Talk about the stock price of a company in either your prior line of work or one that interests you.
95.    Describe the stock of a company you have been watching? Why did the stock price decrease when it did and increases when it did?
96.    Tell me about your portfolio. How has it performed in the last three years?
97.    Give a bull and bear case on X energy commodity.
i.    Commodities are a strict result of supply and demand. What is today’s demand and what is expected in the future? Energy needs are rising, but there’s a huge push to remove reliance on fossil fuels and more to renewable sources like solar and wind. Conversely, there is a constant discussion concerning supply: oil and gas are supposed to dwindle. This point to bull cases for certain energy commodities, but crude oil has fallen dramatically from mid-2008 to 2009 because of the slowing global economy and rising inventories.
98.    You have three companies in three different industries: retail, tech, and pharmaceuticals. What would you look for in their 10-Ks beyond financials?
i.    In retail, look for strategy of product differentiation and sustainability of that strategy (zero in on competitors). For tech, what is the growth of its industry or market year (zero in on longevity of product life)? For pharmaceuticals, measure the current patents in terms of years to expiration, and note the level of development of drugs in its pipeline.
99.    What is the difference between technical analysis and fundamental analysis?
i.    Technical analysis is the process of picking stocks based on historical trends and stock movements mainly based on charts. Fundamental analysis is examining a company’s fundaments, financial statements, industry, etc. and picking stocks that are undervalued.
100.    What are the drivers of growth?
i.    Growth can be operationally organic (from inside), acquisition based, or financial (recapitalizing).
101.    Would I be able to purchase a company at its current stock price?
i.    Due to the fact that purchasing a stake in a company will require paying a control premium, most of the time a buyer would not be able to simply purchase a company at its current stock price. The current shareholders require a premium to be convinced to tender their shares. Premiums usually range from 10-30%.
102.    What is correlation?
i.    Correlation is the way two stocks, or investments, move in relation to each other. If two stocks have a strong positive correlation, when one moves up the other would move up as well. Correlation ranges between -1 and 1.
103.    What is diversification?
i.    Process of creating a portfolio made up of a wide variety of investments with the goal being a higher return and lower risk than putting all capital into only a few investments. It means investing in stocks, bonds, alternative investments, etc. it also means investing across different industries, picking investments that have a low correlation so they balance each other out during economic conditions. Systematic risk is the risk that affects the entire market, while unsystematic risk affects only specific industries. If properly diversified, an investor can eliminate unsystematic risk from their portfolio, so they limit the risk associated with one individual stock and their portfolio will only be affected by factors affecting the entire market.
104.    If you add a risky stock into a risky portfolio, how is the overall risk of the portfolio affected?
a.    It depends on the stock relative to that of the portfolio, or the correlation of the new investment to the portfolio. A portfolio’s overall risk is determined not just by the riskiness of its individual positions, but by how these positions are correlated with each other. The risk effect of adding a new stock to an existing portfolio depends on how that stock correlates with the other stocks in the portfolio. Thus, it could potentially lower the overall risk of the portfolio.
105.    Put the following portfolios consisting of 2 stocks in order from the least risky to the most risky and explain why.
a.    A Portfolio of a shoe store stock and an oil company stock?
b.    A portfolio of a SUV car company stock and an oil company stock?
c.    A portfolio of a shoe store stock and a high-end clothing store stock?
i.    The least risky is B, then a, then c. The least risky is the one where the two securities have a strong negative correlation, since stocks with a negative correlation tend to move in the opposite direction under the same circumstances. The value of the portfolio will remain relatively stable over time, making it less risky. High oil prices is bad for an SUV car company, since less people will want to purchase gas-guzzlers, but is good for oil companies. C is most risky because shoes and clothing are both apparel companies and have a strong positive correlation, so they tend to move together under the same circumstances, and are the most risky. A is the middle because shoes and oil have a weak correlation around 0, so the securities generally don’t move in the same direction under the same circumstances.
106.    What kind of stocks would you issue for a startup? For a well-established firm?
i.    A startup has more risk than a well-established firm. The kind of stocks to issue for a startup would be those that protect the downside of equity holders while giving them upside, so the stock issued may be a combination of common stock, preferred stock, and debt notes with warrants (options to buy stock).
107.    When should a company buy back stock? What signals does this send to the market?
i.    When its stock is undervalued, has extra cash, believes it can make money by investing in itself, or when it wants to increase stock price by increasing EPS due to reduction in shares outstanding or send a positive signal to the market. Example: if a company has suffered decreased earnings because of an inherently cyclical industry and believes its stock price is too low, it will buy back, or if investors are driving down the price precipitously.
108.    What does it mean to short a stock?
i.    It is the opposite of going long. When an investor buys a stock, they believe they can sell the stock for a higher price in the future. When short selling, the investor sells a stock they don’t actually own under the belief they will be able to purchase it for a lower price in the future. Normally, the short seller will borrow the stock form another investor and then sell it. Naked short selling occurs when an investor sells the stock without having any of the stock actually borrowed.
109.    What is liquidity?
i.    How easily an asset or security can be bought and sold on the open markets. Money market accounts and publicly traded large cap stocks are very liquid, while micro-cap stocks could be relatively low liquid due to the limited market demand for them.
ii.    How quickly an asset can be converted into cash. Cash is the most liquid asset.
iii.    A more liquid investment is relatively safer since the investor can sell it at any time.
110.    When should a company issue stock rather than debt to fund its operations?
i.    If it believes its stock price is inflated, it can raise money on good terms by receiving a high price for shares. If it wants to adjust the debt to equity ratio, which in part determines bond rating?  Bond ratings determine the pricing of its capital structure. If bond rating is poor because struggling with large debts, the company may issue equity to pay down debt. If projects for which money is being raised may not generate predictable cash flows in immediate future, company may not be able to pay consistent coupon payments required by debt so issue stock to raise money. Example: startup company- issue stock because venture will probably not generate predictable cash flows needed to make regular debt payments and so the risk of venture is diffused among shareholders.
111.    When should a company issue debt instead of issuing equity?
i.    A company needs a steady cash flow before issuing debt, or else it will fall behind interest payments and get its asset seized. Once a company can issue debt, it should prefer issuing debt since it is cheaper than equity. Interest payments are tax deductible and therefore provide interest tax shields. It may also try to raise debt if it feels its stick is undervalued and would not raise the capital needed from an equity offering. Issuing debt sends a quieter signal to the market regarding its current cash situation.
ii.    If the expected return on equity is higher than the expected return on debt, a company will generally issue debt. Example: a company believes that projects completed with $1 mil raised will increase its market value from $4 mil to $10 mil. If raised by issuing equity, it will sell 20% (1 mil/5 mil) of the company after the capital infusion. This would then grow to 20% of 10 million (2 million), so it will cost the company $1 million (2-1). If raised by issuing a $1 mil bond that requires $300,000 in interest payments over its life, and thus will only cost $300,000. Thus, it will choose debt, since it is cheaper than equity.
112.    Is the dividend paid on common stock taxable to shareholders? Preferred stock?
i.    Dividend paid on common stock is taxed at the firm level, since the dividend comes out from the net income after taxes, and the shareholders are taxed for the dividend as ordinary income on personal income tax. Preferred stock dividend is treated as interest expense and is tax-free at corporate level.
113.    When would an investor buy preferred stock?
i.    Wants the upside potential of equity and wants to minimize risk through receiving steady interest-like dividend payments that are more assured than the dividends on common stock. Get superior right to company’s assets in event of bankruptcy.
ii.    Corporation would invest in preferred stock because dividends on preferred are taxed at a lower rate than interest rates on bonds.
114.    Why would a company distribute earnings through dividends to common stockholders?
i.    Regular dividend payments signal that the company is healthy and profitable, which attracts more investors or shareholders, potentially increasing stock price. Also, if it lacks profitable investment opportunities.
115.    Why would the stock price of a company decrease when it announced increased quarterly earnings?
i.    The entire market was down (or the sector of the company), which had more impact than the company’s positive earnings, or the Street was expecting earnings to increase more than they did
116.    How can a company raise its stock price?
i.    Any type of positive news about the company, such as announcing an accretive merger or acquisition that will increase EPS, announcing a change to organization structure through cost-cutting or consolidation, could raise its stock price. If it repurchases stock, it lowers the shares outstanding, raising EPS which will raise stock price, and also sends a positive signal to the market. It can also produce higher earnings, raising EPS higher than anticipated.
117.    If a company’s stock has gone up 20% in the last 12 months, is the company’s stock actually doing well?
i.    It depends on the Beta and the performance of the market. If Beta is 1 and the market went up 30%, the company did not do well compared to the broader market.
118.    What is an Initial Public Offering?
i.    An IPO is the first sale of stock in a previously private company to the public markets, known as going public. Many Companies will go public to raise capital in order to grow business, to allow original owners and investors to cash out some of their investment, and employee compensation. Some negatives for going public include sharing future profits with public investors, los of confidentiality and control, IPO expenses to investment banks, legal liabilities, etc.
119.    Talk about a recent IPO that you have followed? Why did you choose it?
120.    Why do some stocks rise so much on the first day of trading their IPO and others don’t? How is that money left on the table?
i.    Money left on the table means the company could have completed the offering at a higher price (could have sold the same stock in its IPO at a higher price), and that difference in valuation goes to initial investors in the stock rather than the company raising the money. If the stock rises a lot the first day, it is good publicity for the firm.
ii.    Bankers must honestly value a company and its stock over the long term rather than guessing what the market will do. Even if a stock trades up significantly initially, a banker looking at the long term would expect the stock to come down, as long as the market eventually correctly values it.
121.    What is insider trading and why is it illegal?
i.    The illegal activity of buying or selling stock based on information that is not public information. The law against insider trading exists to prevent those with privileged information from using this information to make a tremendous amount of money unfairly.
122.    If you have two companies that are exactly the same in terms of revenue, growth, risk, etc. but one is private and one is public, which company’s shares would be higher priced?
i.    Public will be priced higher due to the liquidity premium an investor willingly pays for the ability to quickly and easily trade the stock on public exchanges ad also for the transparency premium an investor pays since the public company is required to file their financial documents publicly.
123.    Which has a higher growth potential: a stock currently trading at $5 or a stock at $50?
i.    It depends. Growth potential has less to do with stock price than operations and revenue prospects. However, the stock with higher growth potential is most likely the stock with lower market cap. Thus, if the $5 stock has 1 billion shares outstanding and the $50 stock has 10,000 shares outstanding, the $50 stock has a smaller market cap and would most likely have higher growth potential.
124.    If you bought a stock a year ago for $20, sold it today for $25, and received $5 in dividends over the year, what would your overall return be?
i.    Return on Stock= Sales Price + Dividends-Purch Price/ Purchase Price
ii.    25+5-20/20=10/20=50%. Made 50% return on investment.
125.    What is the primary market and what is a secondary market?
i.    The primary market is the market that an investment bank, or firm, sells new securities, a new stock or bond issuance to the first time it comes to market and thus before they go to market. With an IPO or Bond issuance, the majority of these buyers are institutional investors who purchase large amounts of the security.
ii.    The second market is the market that the security, stock or bond, will trade on after the initial offering (NYSE, Nasdaq).
126.    What are some reasons why a company might tap the high-yield market?
i.    Companies with low credit ratings are unable to access investment grade investors and would have to borrow at higher rates in the high yield markets. Other companies must have specific riskier investments that they must pay a higher cost of capital for.
127.    If you read that a certain mutual fund achieved 50% returns last year, would you invest in it?
i.    Past performance is not necessarily an indicator of future results. A mutual fund full of Mortgage Backed Securities could have been up and then been down 90% last year due to the MBS market collapsing. To make an investment decision, need to research more in depth the firm’s holdings. How has the overall market done? How did it do in the years before? Why did it give 50% returns last year? Can that strategy be expected to work continuously over the next five to ten years?
128.    How do you calculate a company’s Days Sales Outstanding?
i.    Average Accounts Receivable/Sales x 365 Days
ii.    Average Accounts receivable= (Ending AR + Beginning AR)/2
129.    If the days sales outstanding of company increased from 53 to 71 days, would you be more or less likely to issue a Buy rating on the stock and why?
i.    Less likely, since when the says sales outstanding increases the company is collecting money from customers slower, since customers went from taking an average of 53 days to pay bills to 71 days. Having faster paying customers when sales grow or stay the same is a good thing, so when it takes longer it is a bad thing.
130.    How do you calculate a company’s Current Ratio?
i.    Current assets/Current liabilities. A high current ratio indicates that a company has enough cash or assets that can quickly turn into cash to cover its immediate payment requirements on liabilities.
131.    If the Current Ratio of a company went down from 2.1 to 1.6, would you be more or less likely to buy the stock and why?
i.    Less likely, since the company is less able to cover its immediate liabilities with cash and other current assets than it was last quarter.
132.    If a Company A has assets of $100 million versus another company B with assets of $20 million, but both have the same dollar earnings, which company would you invest in?
i.    Company B has a higher ROA, since it is able to generate the same earnings with less assets and is thus more efficient. From an ROE and ROI perspective, company A might be a better company but it would be riskier from a bankruptcy perspective.
133.    What is the market risk premium?
i.    The required return that investors require for investing in stocks over investing in risk-free securities. Calculated as the average return on the market-risk free rate
134.    What is default risk?
i.    Risk of a given company going bankrupt
135.    What is default premium?
i.    Difference between the yield on a corporate bond and the yield on a government bond with the same time to maturity to compensate the investor for the default risk of the corporation, compared with the risk-free comparable government security.
136.    What is face value?
i.    Par value of a bond is the amount the bond issuer must pay back at time of maturity. Bonds are usually issued with $1,000 face value.
137.    What is the coupon payment?
i.    The amount that a company will pay to a bondholder normally on an annual or semi-annual basis. It is the coupon rate x the face value of the bond.
138.    What determines the premium you place on growth stocks relative to their peers?
i.    All the criteria that goes towards a good investment determines the premium you place on a growth stock. P/E versus PEG ratio: P/E/EPS growth. The PEG ratio is a trading valuation metric for evaluating the relationship between the price of a stock, EPS and the company’s expected growth. In general, a P/E ratio is higher for companies with higher growth rates, so dividing P/E by the expected growth rate is a convenient metric to compare companies with different growth rate. A fairly valued company should theoretically have a PEG ratio of 1. By setting PEG to 1 and solving for growth rate, you can gather a sense of what premium the market is putting on the particular stock.
139.    What is the difference between an investment grade bond and a junk bond?
i.    An investment grade bond is a bond issued by a company that has a relatively low risk of bankruptcy, a good credit rating, and thus pays a low interest rate. A junk bond is a bond issued by a company that has a high risk of bankruptcy, has poor credit rating, and thus pays a high interest rate.
140.    What is the difference between a bond and a loan?
i.    The market that it is traded on. A bond issuance is usually for a larger amount of capital, is sold in the public market and can be traded. A loan is issued by a bank, and is not traded on a public market.
141.    How do you determine the discount rate on a bond?
i.    Determined by the company’s default risk. Factors influencing the discount rate include a company’s credit rating, the volatility of their cash flows, the interest rate on comparable US bonds, and the amount of current debt outstanding.
142.    How do you price a bond?
i.    The net present value of all future cash flows (coupon payments and par value) expected from the bond using the current interest rate.
143.    If the price of a bond goes up, what happens to yield?
i.    The price and yield of a bond move inversely to one another. When the price of a bond goes up, yield goes down.
144.    Define the difference between the yield and the rate of return on a bond
i.    The yield is the return you earn if you hold the bond to maturity versus the rate of return is the actual realized return to the bond holder. If the bond is sold before maturity, the rate of return can be higher or lower than the yield. A bond may have a promised yield of 5%, but the economic crisis hit and interest rates have fallen. This increases your rate of return if you sell now; if you hold to maturity then yield and return will be the expected 5%.
145.    If you believe interest rates will fall, and want to make money due to the capital appreciation on bonds, would you buy them or short sell them?
i.    Since prices move inversely to interest rates, if you believe interest rates will fall, bond prices will rise and therefore you should buy bonds.
146.    Who is a more senior creditor, a bondholder or stockholder?
i.    A bondholder is more senior. Stockholders must wait until bondholders are paid during a bankruptcy before claiming company assets. Interest payments are paid to bondholders before equity holders receive any dividends.
147.    What is the relationship between a bond’s price and its yield?
i.    They are inversely related. If a bond’s price rises, it’s yield falls. Current yield= interest paid annually/market price * 100%
148.    You have an 8% note maturing in 5 years trading at 80. What is the current yield?
i.    20/80=25%/5-5%+8/80=15% minus compounding = 14% approx
149.    How are bonds priced?
i.    Bonds are priced based on the net present value of all future cash flows expected from the bond.
150.    If I have a bond with a 5% coupon. What happens to the market price when the interest rates rise to 10%? How are the coupons affected?
i.    When the interest rates rise, the market price of the coupon bond decreases because the investor can obtain a higher interest rate on the market than what the bond is currently yielding. To make the bond appealing to potential investors, the market price decreases which causes the bond’s return to increase at maturity as means of compensating for the decreased value of coupon payments. The coupons remain constant; the new market price instead balances the yield to keep it neutral with the current market.
151.    What are the factors that affect option pricing?
i.    An option conveys the right, not obligation, to engage in a future transaction on some underlying security. Several factors influence an option’s premium, which is intrinsic value + time value. A change in the price of the underlying security either increases or decreases the value of an option, and the price changes have an opposite effect on calls and puts. The strike price determines whether the option has intrinsic value and it generally increases as the option becomes further in the money. Time influences option pricing because as expiration approaches, the time value of the option decreases. A security’s volatility impacts the time value of a premium, and higher volatility estimates generally result in higher option premiums for both puts and calls. Dividends and the current risk-free interest rate have a small effect known as the “cost of carry” of shares in an underlying security.
152.    Explain put-call parity.
i.    The relationship between the price of a call option and put option with an identical strike price and expiration date. It is derived using arbitrage arguments, and shows that a portfolio of call options and x amount of cash equal to the PV of the option’s strike price has the same expiration value as a portfolio compromising the corresponding put options and the underlying option. The parity shows that the implied volatility of calls and puts are identical. Also, in a delta-neutral portfolio, a call and a put can be used interchangeably.
153.    What is meant by the term securities lending?
i.    The loan of a security from one broker/dealer to another, who must eventually return the same security as repayment. The loan is often collateralized. Securities lending allows a broker/dealer in possession of a particular security to earn enhanced returns on the security through finance charges.
154.    What is arbitrage?
i.    Occurs when an investor buys and sells an asset or related assets at the same time in order to capture a guaranteed profit from the trade by taking advantage of the temporary price differences that occur when two assets are inaccurately priced by the markets. Because of the technology now employed in the markets today, the only people who can truly take advantage of arbitrage opportunities are traders with sophisticated software since the price inefficiencies’ often close in a matter of seconds.
155.    What is convertible arbitrage?
i.    An investment strategy that seeks to exploit pricing inefficiencies between a convertible bond and the underlying stock. Managers will typically long the convertible bond and short the underlying stock.
156.    If you buy a normal bond at par and you get the face amount at maturity. Is that most similar to buying a put, selling a put, buying a call, or selling a call?
i.    Selling a put because if the stock decreases in value, you lose money, like a bond defaulting. But if it’s neutral, you’re neutral in both cases.
157.    Why could two bonds with the same maturity, same coupon, from the same issue be trading at different prices?
i.    One of the bonds could be callable, put-able, or convertible. A bond that is put-able or convertible demands a premium, and a callable bond trades at a discount.
158.    What are bond ratings?
i.    A grade given to a bond based on its risk of defaulting that are issued by independent firms (Standard and Poor’s, Moody’s and Fitch) and are updated over the life of the bond. The lower the grade, the more speculative the stock, and all else equal, the higher the yield. They range from AAA, which are highly rated investment grade bonds with low default risk, to C, which are junk bonds, or D, which means that the bond is in default and not making payments.
159.    Which corporate bond would have a higher coupon, AAA or BBB? What are the annual payments received by the owner of a 5 year zero coupon bonds?
i.    The BBB bond would have a higher coupon because it is perceived to have a higher risk of defaulting. To compensate investors for this higher risk, lower rated bonds offer higher yields. The owner of the zero coupon bond receives no annual payments, instead the owner pays a discount upfront and then receives the face value at the time of maturity.
160.    What major factors affect the yield on a corporate bond?
i.    Interest rates on comparable U.S. Treasury bonds, and the company’s credit risk.
ii.    Corporate bond yields trade at a premium, or spread, over the interest rate on comparable US treasury bonds (a 5 yr corporate bond trading at a premium of .5% or 50 bases points over the 5 yr Treasury note is priced at 50 over). The size of this spread depends on the company’s credit risk: riskier=higher interest rate the company must pay to convince investors to lend it money and thus the wider the spread over US Treasuries.
161.    If interest rates are falling, would you buy a 10 year coupon bond or 10 year zero coupon bond?
i.    The 10 year zero coupon bond, because it is more sensitive to changes in interest rates than an equivalent coupon bond, so its price will increase more than the price of the coupon bond if interest rates fall.
162.    Which is riskier: a 30-year coupon bond or a 30-year zero coupon bond?
i.    Zero coupon bond is riskier since its price is more sensitive to changes in interest rates, and will yield $0 until its date of maturity since it pays no interest but instead one lump sum upon maturity. A coupon bond pays regular interest payments than pays the principal when the bond matures, so it is less risky since you receive some money back before over time. Even if the company defaults on its debt prior to maturity, you will have received some payments with the coupon bond, while the zero coupon bond you have to wait to receive any money back.
163.    What is the Long Bond? What is it trading at?
i.    The U.S. Treasury’s 30-year bond.
164.    What is the current yield on the 10-year Treasury note?
165.    If the price of 10 yr Treasury note rises, what happens to the note’s yield?
i.    Since price and yield are inversely related, when the price of the note rises, its yield falls.
166.    What would cause the price of a treasure note to rise?
i.    If the stock market is extremely volatile and investors are fearful of losing money, they will desire risk free securities, which are government bonds. The increase in demand for these securities will drive the price up, and thus the yield will fall.
167.    If you believe interest rates will fall, should you buy bonds or sell bonds?
i.    Since bond prices rise when interest rates fall, buy bonds.
168.    If a company has $300 million of senior debt and $300 million of junior debt. The senior debt has an interest rate of L+300 and, in default, would recover 50%; the junior debt would recover 20% in default. What should the interest rate be on the junior debt?
i.    Loss on default*probability of default=incremental interest that needs to be paid. 80% loss*5% probability (assumption you have to make)=400 basis points over the senior debt or L+700.
169.    What if this was an LBO scenario and you had a sponsor putting in 500 million of equity?
i.    The company would be less risky because it has more liquidity now.
170.    What are the three ways to create equity value?
i.    EBITDA/earnings growth, FCF generation/debt pay-down, multiple expansion
171.    You have a company with 2x senior leverage and 5x junior leverage. What happens when you sell the business for 8x EBITDA? What about for 7x EBITDA?
i.    It’s a de-leveraging transaction because pro-forma the company will have lower total debt to EBITDA ratio
ii.    On a firm basis, it has a neutral impact, but it is de-leveraging on a senior debt basis
172.    How many basis points equal 1.5 percent?
i.    Bond yields are measured in basis points, which are 1/100 of 1%. So 1.5%= 1.5×100=150 basis points.
173.    Does inflation hurt or help creditors? Why?
i.    Hurts. Creditors assign interest rates based on the risk of default as well as the expected inflation rate. When creditors lend out money at a fixed rate, the inflations cuts into the real percentage return they make. So if lent out at 5% a year, and inflation is expected to be 2%, they expect to make a 3% real gain. However, if it increases to 4%, they only make 1% on the loan.
174.    If the president is impeached, how would interest rates be affected?
i.    Any negative news about the country often leads to fears that the economy will decline, so the Fed would balance those fears by lowering interest rates to stimulate economic expansion.
175.    How does the government react to fear of hyperinflation?
i.    It uses fiscal (taxation, government spending to regulate aggregate level of economic activity) and monetary (Fed’s use of interest rates, reserve requirements, etc) policies to slow the economy and defuse hyperinflation.
ii.    Ex: Increasing taxes and decreasing spending slows down growth in the economy and fights inflation. Raising key interest rates will slow the economy, reduce the money supply, and slow inflation.
176.    What is your outlook on the economy? (stock market, consumer spending, unemployment- way interest rats, inflation, and bonds interact)
177.    If the stock market falls, what would happen to bond prices and interest rates?
i.    Expect bond prices to increase and interest rates to fall. When the stock market falls, investors flee to safer securities, like bonds, which causes demand to rise and thus prices. Since prices and yield move inversely, if bond prices rise, yield falls. The government may lower interest rates in an attempt to stimulate the economy.
178.    When unemployment decreases, what happens to inflation, interest rates, and bond prices?
i.    Inflation up, interest rates up, bond prices down.
179.    If inflation last month was very low, but bond prices closed lower, why would this happen?
i.    Bond prices are based on expectations of future inflation, so if traders expect future inflation to be higher regardless of last month’s inflation figures they will bid bond prices down today since the demand for bonds today will be lower, increasing the yields to match the increased inflation expectations.
ii.    A report showing last month inflation was benign would benefit bond prices to the extent that traders believed it was an indication of low future inflation as well.
180.    What is a bond’s “Yield to Maturity”?
i.    The rate of return, expressed as an annual rate, on a bond if it is purchased today for its current price and held through its maturity date. Calculation is based on current market price, coupon payments, face value, and time to maturity. If the coupon yield of a bond (coupon/face) is higher than its current yield (coupon/price), it is selling at a premium. If the yield is lower than the current yield, it is selling at a discount.
181.    What will happen to the price of a bond if the fed raises interest rates?
i.    If interest rates rise, newly issued bonds offer higher yields to keep pace. Therefore, existing bonds with lower coupon payments are less attractive, and the price must fall to raise the yield to match the new bonds.
182.    What is a Eurodollar bond?
i.    A bond issued by a foreign company, but issued in US dollars rather than their home currency.
183.    What is a callable bond?
i.    A bond that allows the issuer of the bond to redeem the bond prior to its maturity date, thus ending their coupon payments. However, a premium is usually paid by the issuer to redeem the bond early.
184.    What is a put bond?
i.    The opposite of a callable bond. Gives the owner of bond the right to force the issuer to buy back the security from them at face value, prior to the maturity date.
185.    What is a convertible bond?
i.    Can be converted into equity over the course of the life of the bond. A bondholder can decide that equity in the company is worth more than the bond and the company can essentially buy back their debt by issuing new equity.
186.    What is a perpetual bond?
i.    A bond that pays coupon payments every period indefinitely (or the company goes into default) with no repayment of the principal amount (par value).
187.    How would you value a zero coupon perpetual bond?
i.    Zero. A zero coupon doesn’t pay any coupons, and a perpetual bond has no maturity date or par value- it pays only coupon payments. Thus if the coupon is zero and if that continues perpetually, you will never get paid so worth nothing.
188.    How would you value a perpetual bond that pays you $1,000 a year in coupon?
i.    Divide the coupon by the current interest rate. A corporate bond with an interest rate of 10% that pays $1,000 a year in coupons forever would be worth $10,000.
ii.    Value of perpetual bond= coupon payment/current interest rate on comparable bonds
189.    What is duration?
i.    A measure of the sensitivity of the price of a bond to changes in interest rates, expressed as a number of years. When interest rates rise, the Present Value of the future cash flows go down more than those earlier in the bond’s life cycle. Formally, it is the weighted average maturity of cash flows. If your cash flow occurs faster or sooner your duration is lower and vice versa. A 4 year bond with semi-annual coupons will have a lower duration than a 10 year zero-year coupon bond. The larger the duration number, the greater the impact of interest rate fluctuations on bond prices.
190.    What does the term delta mean?
i.    The change in price of an option for every one point move in the price of the underlying security (a first derivative)
191.    What is meant by gamma?
i.    A measurement of how fast delta changes, given a unit change in the underlying price (a second derivative)
192.    What does the term vega mean?
i.    The change in the price of an option that results from a 1% change in volatility.
193.    What is meant by rho?
i.    The dollar change in a given option’s price that results from a 1% change in interest rates
194.    What the term theta mean?
i.    The ratio of the change in an option’s price to the decrease in its time to expiration, also called time decay
195.    What is convexity?
i.    As duration is the measure of sensitivity of a bond’s price to changes in interest rates, convexity is the measure of sensitivity of a bond’s duration to changes in interest rates. In essence, duration could be considered the first derivative of a bond’s interest rate sensitivity and convexity the second.
196.    What is the order of creditor preference in the event of a company’s bankruptcy?
i.    The first creditors to be paid would be the senior debt holders, usually banks or senior bondholders who usually have some of the firm’s assets as collateral. Then those holding subordinated debt, then preferred stockholders, then common stockholders.
197.    What are some ways to determine if a company poses a credit risk?
i.    Look at their credit rating, which is provided by Standard & Poors and Moody’s. Can look at long term measures like the long term debt ratio, debt/equity, and interest coverage ratio (EBIT/Interest Expense), which shows the company’s ability to pay its interest expense with its earnings and again compare these to industry averages. Can also compare the company’s Current Ratio and Quick Ratio to other similar companies in their industry.
198.    Why is a firm’s credit rating important?
i.    The lower a firm’s credit rating, the higher its risk of bankruptcy and therefore the higher the cost of borrowing capital.
199.    What do you think the Fed will do with interest rates over the next 5 yrs?
i.    As the economy recovers, you can expect that the fed will raise rates slowly to stunt inflation by taking money out of the overall money supply. The increase in production as the economy betters will make up for the tightening policy. If the economy does not get better, the Fed won’t raise rates.
200.    What is the Fed Funds rate? Other economic indicators?
201.    What steps can the Fed take to influence the economy?
i.    Open Market Operations: the fed buying and selling securities (government bonds) to change the money supply. Buying government securities increases the money supply and stimulates expansion, selling securities shrinks the money supply and slows the economy.
ii.    Raise or lower interest rates: the discount rate is the interest rate the Fed charges banks on short-term loans. The federal funds rate is the rate banks charge each other on short-term loans. When the Fed lowers these rates, it signals an expansionary monetary policy.
iii.    Manipulate the reserve requirements: the reserve requirement is the amount of cash a bank must keep on hand to cover its deposits (money not loaned out). When this requirement is lowered, more cash is loaned out and is pumped into the economy, and is therefore expansionary policy.
202.    What do you think of Bernanke and how is he likely to differ from Greenspan?
203.    What is LIBOR? How is it often used?
i.    The London Interbank Offered Rate tracks the daily interest rates at which banks borrow unsecured funds from banks in the London wholesale money market, and is roughly comparable to the Fed Funds rate. It is used as a reference for several financial instruments, such as interest rate swaps or forward rate agreements, and they provide the basis for some of the world’s most liquid and active interest rate markets.
204.    What is the effect on U.S. multinational companies of the U.S. dollar strengthening?
i.    Multinationals see earnings decrease when dollar strengthens, since sales in foreign currencies don’t amount to as many US dollars when the dollar strengthens.
205.    What is the currency risk for a company selling its products internationally? What is the currency risk for a company manufacturing its products overseas?
i.    Currency risks created by international sales: If the dollar strengthens against the other currency it is selling a product at, then it will be making less dollars than it had previously anticipated unless it reacts by changing its prices.
ii.    Manufacture overseas: cost of operations will be sensitive to price of foreign currency relative to dollar. If foreign currency weakens, can make product cheaper, sell for lower prices, and gain competitive advantage. If it strengthens, labor costs will increase.
iii.    Also if company has major competitors in foreign countries, price of currency in those countries influence prices at which foreign competitors sell cars, so at currency risk.
206.    When currencies fall in other countries, why are US based investment banks hurt?
i.    If investment banks held currency or bonds in currencies that fell, these assets turned non-performing and are essentially worthless. If the country’s government defaults on its government-backed bonds, banks hurt by dropping currencies and by loan defaults.
207.    If the U.S. dollar weakens, do interest rates generally rise, fall, or stay the same?
i.    Rise. When the dollar weakens, price of imported goods rise when measured in US dollars, which means higher inflation. Higher inflation puts pressure on the Fed to raise interest rates.
208.    If U.S. inflation rates fall relative to a foreign country, what happens to the relative strength of the dollar and the exchange rate?
i.    The dollar strengthens. If inflation rates fall relative to other country, more of that country’s currency will be in circulation, so dollars would be worth more of the foreign currency, allowing the dollar to strengthen relative to that currency.
209.    If a foreign country’s interest rate increases relative to the US interest rate, what happens to the exchange rate between the foreign currency and the dollar?
i.    The international currency will strengthen relative to the dollar.
210.    What is the difference between currency devaluation and currency depreciation?
i.    Devaluation occurs in a fixed-exchange-rate system, like China, when the government changes the exchange rate of its currency, thus the exchange rate is fixed as a function of government policy. Depreciation occurs when a country allows its currency to move according to the international currency exchange market, and the country’s currency loses value.
211.    What are the main factors that govern foreign exchange rates?
i.    Interest rates, inflation, and capital market equilibrium.
212.    What is the spot exchange rate?
i.    The rate of a foreign-exchange contract for immediate delivery. Spot rates are the price that a buyer will pay for a foreign currency.
213.    What is the forward exchange rate?
i.    The rate at which traders are willing to exchange currencies in the future, or the price that a foreign currency will cost at some time in the future. A company can enter into a forward contract on exchange rates to help hedge against exchange rate fluctuations in the future.
214.    What is the difference between strong and weak currency?
i.    A strong currency is one whose value is rising, while a weak currency is one whose value is falling.
215.    How is the market exchange rate between two country’s currencies determined?
i.    The interest rate in the two countries: if the interest rate of a foreign country relative to the home country goes up, the home currency weakens. When interest rates in a country rise, investments held in that country’s currency will earn a higher rate of return and demand for that country’s currency will rise because people will want to invest in that country. The rise in demand will cause the currency to strengthen.
ii.    Inflation rates: if inflation in foreign country is expected to be higher than home country, then foreign country’s currency will be devalued and will be worth less.
216.    If the spot exchange rate of dollars to pounds is $0.70/1 pounds and the one-year forward rate is $1.00/1 pounds, is the dollar forecast strong or weak relative to the pound?
i.    They believe that the dollar will strengthen against the pound in the coming year: one dollar will be able to buy more pounds one year from now than it can now.
217.    The current one year interest spot rate is 6% and the six-month interest spot rate is 6.2%. What is the implied forward rate for the second half of the year?
i.    The rate of the first six months and second half of the year must average out to give 6% for the full year. So 6%=(6.2%+unknown forward rate)/2, which solves to 5.8%. The spot rate is the price that is to be paid immediately. Forward rates are the projected spot rates, which can fluctuate based on the market. Buying a forward means you’re locking in a price now for future settlement, through the true spot rate that settles then may be different.
218.    What is a derivative?
i.    A type of investment that derives its value from the value of other assets like stocks, bonds, commodity prices or market index values. Some derivatives are futures contracts, forwards contracts, calls, puts, etc.
219.    What are options? A call option and put option?
i.    A type of derivative that gives the bearer the option to buy or sell a security at a given date, without the option to do so. The buyer of the option pays an amount less of the actual value of the stock and has the option to buy or sell the stock for a set price on or before a set date.
ii.    A call option gives the holder the right to purchase an asset for a specified exercise price on or before a specified expiration date. A put option gives the holder the right to sell an asset for a specified exercise price on or before a specified expiration date.
220.    What is hedging?
i.    A financial strategy designed to reduce risk by balancing a position in the market. For example, an investor that owns a stock could hedge the risk of the stock going down by buying put options on that security or other related businesses in the industry.
221.    What are the main difference between futures and forward contracts?
i.    Forward contracts are a type of derivative that arranges for the future delivery of an asset on a specific date at a specific price, thus it is in an agreement that calls for future delivery and no money is changed initially in order to protect each party from future price fluctuations. They are traded over the counter, and are more flexible because they are privately negotiated and can represent any assets and can change settlement dates should both parties agree.
ii.    Futures contracts are a financial contract obligating the buyer to purchase an asset like a commodity or another financial instrument at a specified price on a specified date. They are strictly defined in their terms and highly standardized, which allows them to be publicly traded on exchanges.
222.    What factors influence the price of an option?
i.    Current stock price, exercise price, stock volatility, time to expiration, interest rate, and the dividend rate of the stock.
ii.    For example: when the current stock price or interest rate increase, the call option price increases and the put option price decreases. When the exercise price or dividend payout increases, call option price decreases and put option price increases. When volatility or time to expiration increase, call option and put option price increase.
223.    If an option is “in the money” what does that mean?
i.    In the money when exercising the option means that at this point in time, if an investor decides to exercise their option, they will make money based on the difference between the exercise price and market price. A call option is in the money when its exercise price is below the market price, so an investor can purchase the asset at the exercise price and instantly sell it at the market price. A put option is in the money when its exercise price is above the market price since an investor can buy the asset at the market price and instantly sell it at the exercise price.
224.    What are swaps? Explain how a swap works.
i.    A swap is an agreement to exchange future cash flows, such as a credit default swap issued by banks as a type of insurance against companies not being able to pay back their debt. The most popular forms include foreign exchange swaps and interest rate swaps. They are used to hedge volatile rates, such as currency exchange rates or interest rates. Swaps can benefit both companies if one has access to a lower floating rate, and one has access to a lower fixed rate, and each desires the rate the other company has access to.
225.    When would you write a call option on a company’s stock?
i.    When you expect the company’s stock to fall or stay the same. A call option on a stock in a bet that the value of the stock will increase, you would be willing to write or sell a call option on the company’s stock to an investor if you believed the company’s stock would not rise. The profit made would be equal to the option premium you received when you sold the option.
226.    When would you buy a put option on a company’s stock?
i.    Buying a put option gives the option to sell the stock at a certain price, so would do this if expect the price of the stock to fall.
227.    If the strike price on a put option is below the current price, is the option holder at the money, in the money or out of the money?
i.    A put option gives the holder the right to sell a security at a certain price, the face that the strike (or exercise) price is below the current price would mean that the option holder would lose money, so out of the money.
228.    If the current price of a stock is above the strike price of a call option, is the option holder at the money, in the money, or out of the money?
i.    A call option gives the holder the right to buy a security, the holder is in the money (making money).
229.    If I hold a put option on a company’s stock with an exercise price of $40, the expiration date is today, and the company is trading at $30. About how much is my put worth, and why?
i.    $10, because you can sell a share of stock for $40 and buy it for $30. If the expiration date were in the future, the option would be more valuable, because the stock could conceivably drop more.
230.    What is the Black-Sholes model?
i.    The industry standard model for pricing option. The formula has 6 inputs that effect the price including the current price of the asset, the exercise price of the option, the time until expiration, the current risk free rate, the asset’s variance and the dividend yield.
231.    When would a trader seeking profit from a long-term possession of a future be in the long position?
i.    The trader in the long position is committed to buying a commodity on a delivery date. They would hold this position if they believe the commodity price will increase.
232.    All else being equal, which would be less valuable: a December put option on eBay stock or a December put option on Home Depot stock? How about a more volatile stock or less volatile stock?
i.    The put option on Home Depot stock should be less valuable, since eBay is a more volatile stock and the  more volatile the underlying assets, the more valuable the option.
233.    All else being equal, which would be more valuable: A December call option or a January call option?
i.    The January option: the later the expiration date, the more valuable the option.
234.    Why do interest rates matter when figuring the price of options?
i.    Due to net present value: higher interest rates lower the value of options since the PV of that option will be lower.
235.    Describe a recent M&A transaction that you’ve read about.
i.    Ex: Sears/Kmart 2004 merger: That cash and stock transaction was worth an estimated $11 billion. Deal was advertised as a merger of equals and the Sears name will remain, but Kmart acted as an acquirer by the structure of the deal. Sears shareholders were offered choice between $50 in cash or half of 1 share of Sears Holdings, the new parent company, which was valued at $50.61. Kmart shareholders received 1 share of Sears Holdings for each of their shares, which closed the day before the deal was announced at $101.22. To purchase the larger Sears, Kmart used the strong gains in its stock during the previous year before the deal and its $3 billion in excess cash. At the time of the announcement, Sears and Kmart expected cost savings and increased sales of $500 mil a year, after the merger is completed.
236.    What were the reasons behind an M&A transaction you’ve read about? Does that transaction make sense?
i.    Ex: Sears/Kmart- brought together two giant, struggling companies in hopes that combined they would be better able to compete with other leading retailers (Wal-Mart, Target, Home Depot). The deal created the 3rd largest retailer in the country behind Wal-Mart and Home Deport. The combined firm hopes to blend both of the firm’s strong suits, offering quality appliances and tools and a reputation for good service to Kmart shoppers, and discount clothing and low prices to Sears customers. Increased shopping convenience is expected to allow the combined firm to formidably battle against competitors. Target lost its No. 3 retailer standing as a result of the deal.
237.    Name two companies that you think should merge.
i.    Identify synergies between two companies, will not raise antitrust issues with FTC
238.    What are the three types of mergers and what are the benefits of each?
i.    A horizontal merger is a merger with a competitor and will ideally result in synergies. A vertical merger is a merger with a supplier or distributor and will ideally result in cost cutting. A conglomerate merger is a merger with a company in a completely unrelated business and is most likely done for market or product expansions, or to diversify its product platform and reduce risk exposure.
239.    What are some reasons that two companies would want to merge?
i.    The target company is seen as undervalued. Synergies can be obtained by combining their operations, gaining a new market presence, an effort to consolidate operations, grain brand recognition, grow in size, potentially gain the rights to some property (physical or intellectual) that they couldn’t gain as quickly by creating or building it on their own. A larger company is more industry-defensible (more resilient to downturns or more formidable competitor). Provides growth (versus organic growth which may have slowed or stalled), and can be a use for excess cash. Also, management ego in the desire to run a larger company and increase their own compensation.
240.    What are some reasons that two companies would not want to merge?
i.    Synergies they are looking to gain through the merge will not occur, many times a company will just want to merge due to management ego and wanting to gain media attention, and high investment banking fees associated with completing a merger.
241.    What are synergies?
i.    Improvements that result from the combination of two companies, resulting in a more valuable company than the sum of the values of the two individual companies together. Can result from cost cuts due to reduction in redundant management, employees, office size, etc, or can include revenue generating synergies such as ability to raise prices because of reduced competition, cross-marketing, and economies of scale.
242.    Why could you use options outstanding over options exercisable to calculate transaction price in an M&A Transaction?
i.    Options outstanding represent the total amount of options issued. Options exercisable are options that have vested and can actually be exercised at the strike price. During a potential transaction, all of the target’s outstanding options will vest immediately and thus the acquirer must buy out all option holders.
243.    What is the difference between a strategic buyer and a financial buyer?
i.    A strategic buyer is a corporation that wants to acquire another company for strategic business reasons in order to enhance their business strategically, through synergies, cost cutting, or growth potential. A financial buyer is traditionally a group of investors that wants to acquire a company purely as a financial investment, looking to gain the income the company produces. An example is a private equity fund doing a leveraged buyout of the company.
244.    Which will normally pay a higher price for a company, a strategic or financial buyer?
i.    A strategic buyer will normally pay a higher price, due to their willingness to pay a premium to potentially gain the synergies of lowering costs, improving their existing business, and revenue synergies. The financial buyer look at the company purely in terms of return on a standalone basis unless they have other companies in their portfolio that could significantly improve operations of the target.
245.    You are advising a client in the potential sale of the company. Who would pay more for the company: a competitor or an LBO fund?
i.    A competitor. A strategic buyer would typically pay more due to the additional benefits, synergies, from the purchase and thus higher cash flows from the purchase than would an LBO fund which is traditionally a financial buyer.
246.    What is a stock swap?
i.    When a company purchases another company by issuing new stock of the combined company to the old owners of the company being acquired, rather than paying in cash. The acquired company agrees to be paid in stock of the new company because they believe in the potential for success in the merger. They are more likely to occur when the stock market is performing well and the stock price of the acquiring firm is relatively high, giving them something of high value to purchase the company with.
247.    Are most mergers stock swaps or cash transactions and why?
i.    In strong markets, most mergers are stock swaps because the stock prices of companies are so high, and because the current owners will most likely desire stock in the new company anticipating growth in the strong market.
248.    Why pay in stock versus cash?
i.    If a company pays in cash, the owners receiving the cash pay taxes on the cash received. If the owners of the company being acquired want to be part of the new company, they may prefer to gain stock. Current market performance may also affect the stock/cash decision. If the market is performing poorly, or is highly volatile, the company being acquired may prefer cash.
249.    What is a dilutive merger?
i.    A merger in which the acquiring company’s EPS decreases as a result of the merger. A dilutive merger happens when a company with a lower P/E ratio acquires a company with a higher P/E ratio.
250.    What is an accretive merger?
i.    A merger in which the acquiring company’s earnings per share increase. This happens when a company with a higher P/E ratio acquires a company with a lower P/E ratio. The acquiring company’s EPS should rise following the merger.
251.    Company A, who has a P/E ratio that is 40 times earnings, is acquiring Company B, who has a P/E ratio that is 20 times earning. After A acquires B, will A’s earnings per share rise, fall, or stay the same?
i.    Its EPS will rise, since P/E of the acquirer is higher than the firm it’s purchasing, the new company’s EPS rises. The deal is accretive to the acquirer’s earnings.
252.    If Company A buys Company B, what will the combined company’s balance sheet look like?
i.    The new balance sheet will be the sum of the two company’s balance sheets (add each line on the balance sheet) plus the addition of goodwill for any premium paid on top of the acquired company’s actual assets.
253.    If you merge two companies, what does the pro-forma income statement look like?
i.    Revenues and operational expenses can be added together, plus any synergies. Fixed costs tend to have more potential synergies than variable costs. S, G, & A expenses are another source of synergy, since only need one management to lead merged two companies. D&A will increase more than the sum due to financing fees and assets being written up. This brings you to operating income. Any changes in cash will affect interest income. Interest expense will change based on new capital structure. New or refinanced debt will change pro-forma interest expense. For rolled over debt, since your cash flows will change, your debt pay-down may alter, which also affects interest. Based on all the changes previously, this will cause taxes to differ so cant add the two old tax amounts. Nothing can simply be added together.
254.    What is the difference between shares outstanding and fully diluted shares?
i.    Shares outstanding represent the actual number of shares of common stock that have been issued as of the current date. Fully diluted shares are the number of shares that would be outstanding if all “in the money” options were exercised.
255.    How do you calculate the number of fully dilated shares?
i.    The most common way is the treasury stock method, which involves finding the number of current shares outstanding, adding the number of options and warrants that are currently in the money, and then subtracting the number of shares that could be repurchased using the proceeds form the exercising of the options and warrants.
256.    What is the treasury stock method?
i.    Assumes that acquirers will use option proceeds to buy back exercised options at the offered share price. New shares = common shares + in the money options-(options x strike/offered price)
257.    What is a cash offer?
i.    A payment for the ownership of a corporation in cash.
258.    What are some defensive tactics that a target firm may employ to block a hostile takeover?
i.    A poison pill shareholder rights plan gives existing shareholders the right to purchase more shares at a discount in the event of a takeover, making the takeover less attractive by diluting the acquirer. A Pac-Man defense is when the company which is the target of the hostile takeover turns around and tries to acquire the firm that originally attempted the hostile takeover.
ii.    A white knight is a company which comes in which a friendly takeover offer in the target company which is being targeted in a hostile takeover.
259.    What is a tender offer?
i.    Usually a hostile takeover technique that occurs when the acquiring company offers to purchase the stock of the target company for a price over the current market price in an attempt to take control of the company, or get 50% of the stock that way so it can run and make management decisions including firing top management, without management approval. There are SEC regulations governing this.
260.    What is a leveraged buyout? How is it different than a merger? Why do private equity firms use leverage when buying a company?
i.    A leveraged buyout occurs when a group wants to buy a company now with the intention of exiting the investment usually within 3 to 7 years and potentially changing management to increase the company’s profitability. It is a leveraged buyout because the acquirer will fund the purchase of the company with a relatively high level of debt and then pay off the debt with the cash flows produced by the firm. By the time the fund is ready to sell the company, the business will ideally have little to no debt and the PE firm will collect a higher percentage of the selling price or use the excess cash flow to pay themselves a dividend since the debt has been reduced or paid off. They are typically accomplished by financial groups or company management, whereas M&A deals are led by companies in the industry.
261.    How could a firm increase the returns on an LBO acquisition?
i.    A PE fund can increase potential returns on an investment by changing a number of drivers: increase the sale price at the time of monetization through either an increase in operating profits or multiple expansion, in modeling returns they could increase projections for the acquired companies earnings and cash flows, could negotiate a lower purchase price which would have the same effect of raising the selling price, or increase the amount of leverage or debt they use in purchasing the company which would imply a smaller equity check with a higher internal rate of return on the capital deployed. Although, the higher the leverage, the higher the return, increase the leverage puts financial stress on the company being acquired and increases the bankruptcy risk.
262.    What makes a company an attractive target for a leveraged buy out?
i.    The most important characteristic of a good LBO candidate is steady cash flows, so that the firm can ideally pay off a significant portion or all of the debt raised in the acquisition over the life of the investment horizon, with minimal bankruptcy risk. Some other good characteristics are strong management, cost-cutting opportunities, and a non-cyclical industry.
263.    What are the potential investment exit strategies for an LBO fund?
i.    Sale (to strategic or another financial buyer, IPO or recapitalization (re-leveraging by replacing equity with more debt in order to extract cash from the company).
264.    Why use EBITDA multiples instead of PE multiples?
i.    It can be used for firms reporting losses, it allows you to compare firms regardless of leverage, and because it represents operational cash flow.
265.    Advantages of LBO Financing?
i.    As the debt ratio increases, equity portion shrinks to a level where on can acquire a company by only putting up 20-40% of the total purchase price.
ii.    Interest payments on debt are tax deductible
iii.    By having management investing, the firm guarantees the management team’s incentives will be aligned with their own.
266.    What are some characteristics of a company that is a good LBO candidate?
i.    Steady cash flows, strong management, opportunities for earnings growth or cost reductions, high asset base (for collateral to raise more debt), low business risk and low need for ongoing investment (capex and working capital). Most important is steady cash flows, because sponsors need to be able to pay off the relatively high interest expense each year.
267.    Walk me through S&U?
i.    Sources contain the variable tranches of capital structure. Some examples from senior to junior are bank debt; junior subordinated noted, convertible preferred, hybrids and sponsor equity. Cash belonging to the target can also be used as a source. Finally, proceeds form options exercised as the target are a source. You need to determine how these sources are used; the main component is the purchase of the company, either of the assets or shares. Then is purchase of the target’s options, refinancing debt and transaction costs.
268.    In an LBO, if cost of debt is 10%, what is the minimum required to break even?
i.    Since interest is tax deductible, the break-even return is the after-tax cost of debt. Assuming tax rate of 40%, the break even return is 6%.
269.    In a leveraged buyout, what would be the ideal amount to put on a company?
i.    To maximize returns, the acquiring firm wants to finance the deal with the least amount of equity possible, but has to be careful not to put the company into financial distress by overburdening the acquired company with debt.
270.    How many gallons of white house paint are sold in the U.S. every year?
a.    Start Big: Assume 300 million people in US, and half, 150 mil, live in houses. Average family size is 3, so 50 mil houses in the US. Add 10% for houses used for other purposes beside residential, so 55 mil. If houses painted every 10 years on average, then 5.5 mil houses painted annually. 1 gallon of paint covers 100 square feet, and average house has 2,000 square feet of surface to be painted, so each needs 20 gallons. So 20×5.5 mil houses painted each year= 110 gallons of paint. Assume 70% of houses are white, so 77 gallons of white house paint sold each year.
b.    Start small: A town of 30,000 (1/10,000 of population). Half town lives in houses in groups of three: 5,000 houses plus 10% for other types of houses is 5,500 houses. Painted every 10 years, so 550 houses painted annually. Each house has 2,000 square feet of wall, so need 20 gallons since each gallon covers 100 square feet per house. Thus, 11,000 gallons of house paint each year. 70% white, so 7,700 white. Multiply by 10,000 and have 77 mil gallons of house paint.
271.    How many square feet of loaves of bread is consumed in the United States each month?
i.    300 mil people in America, 200 mil eat pizza. Average person eats it twice a month, two slices at a time so four slices per month. Average slice of pizza is 6 inches wide and 10 inches long, so 30 square inches (Area of triangle=1/2 base x height). 4 slicesx30 square inches=120 square inches. One square foot=12*12=144 square inches, so assume each person eats 1 square foot instead. 200 mil people eat pizza, so 200 mil square feet of pizza consumed monthly in US.
272.    How would you estimate the weight of a Building?
i.    Dimensions of building (height, weight, depth) to determine volume. Does it taper at top? Estimate the composition. Mostly steel, concrete? How much these components weigh per square inch? Considering building empty or with furniture and people- add 20% to weight if so?
273.    If you were going to build a building in a city, and has no physical restraints, no capital restraints, nothing, how tall would you build it?
i.    Measuring the demand for space in a new building, how high people would be willing to purchase space due to safety concerns, how much you can sell the space for in comparison with how much it costs to maintain, how much the demand for the space will grow over the life of the building, so how much extra space should you build into the design.
274.    Why are manhole covers round?
i.    If other shape, it would make it harder to fit with a cover, so would have to rotate it exactly the right way. Many are round because they don’t need to be rotated, since no corners to deal with and won’t fall into hole because rotated wrong way so safer. Concerning corners, cannot cut self on round cover with no corner and easier to transport since can roll it.
275.    If the time on a clock is 4:20, what is the angle between the hour and the minute hands?
i.    Hour hand moves quarter of way between 4 and 5, so it moves ¼ of 1/12 so 1/48 of 360 degrees. Answer is 7.5 degrees.
276.    Two boats are going towards each other at 10 miles per hour. They are 10 miles apart. How long until they hit?
i.    Since both boats are moving at 10 mph, they will crash in ¼ of an hour or 15 minutes.
277.    You have a 5-gallon jug and 3-gallon jug. How will you obtain exactly four gallons of water?
i.    Fill the three gallon jug and pour it into the 5 gallon jug. Repeat, but 1 gallon will remain in the 3 gallon jug since the 5 gallon jug is full. Empty the 5 gallon jug, pour in the 1 gallon and then fill the 3 gallon jug and pour it into the 5 gallon to get 4 gallons. (3+3-5+3=4)
278.    If there are two doors, one that leads to the job offer and the other to the exit that each have one guard in front of the door. One guard always tells the truth, the other one always lies. You can ask one question to decide which door is the correct one. What will you ask?
i.    Ask question that provides same answer no matter who you ask. If I were to ask the other guard which way is correct, what would he say? Truthful guard tell you wrong way, since lying guard would lie. Lying guard tell you wrong way, sine lying about what truth guard would say. So right way is opposite then answer.
279.    If there are 10 machines that produce gold coins, but one of the machines produces coins that are a gram light, how do you know which machine is making defective coins with one weighing?
i.    Have each machine crank different number of coins (machine 1 gives 1 coin, machine 2 gives 2 coins, etc), weigh all coins together- number of grams short of theoretical weight will indicate which machine (2 grams short, machine 2 defective)
280.    What is the decimal equivalent of 3/18 and 11/18?
i.    .167 and .611
281.    What is 43 x 12?
i.    516
282.    A stock is trading at 5 and 1/10. There are 1 million shares outstanding. What is the stock’s market cap?
283.    What is the sum of the numbers from 1-50? 0-100?
i.    Pair up numbers into groups of 51 (1+50,2+49), so 25 groups total. 25×51=1275
ii.    Pair up numbers into groups of 100, so 50 groups: 50×100=5000 plus the midpoint of 50= 5,050
284.    An item that costs $450 is selling for 20% off. How much is the discounted price?
i.    $360.
285.    How many Jet Blue planes will take off in the next hour in the US?
i.    Number of airports in US: Virginia has 7.5 mil approximate population and 2 major airports, so 2/7.5 mil is ratio of airports to people and then multiply that by 300 million people in US and get number of large airports which major carrier departs in the US. If assume one Jet Blue plane departs every 10 minutes, so 6 per hour x large number of airports in US=answer.
286.    If you have 5 white socks and 7 black socks in a drawer, how many do you have to pull out blindly in order to get a matching pair?
i.    3. First one is one color, and second is other color, then third has to be one of the previous colors to make a pair.
287.    Tell me a good joke that is not racist or sexist.
288.    If you are driving two miles on a one mile track, and do one lap at 30 miles an hour, how fast must you go to average 60 miles an hour?
i.    Impossible. Did lap in 1/30 of hour so 2 minutes. To average 60 miles an hour total would have to do 2/60 in an hour so in 2 minutes. Since have already gone 2 minutes, impossible to average 60 miles an hour which is supposed to take a total amount of time of 2 minutes.
289.    You play a game of dice where you are paid the equivalent amount of dollars to the number you roll. You roll one fair six-sided die. How much are you willing to pay for this roll?
i.    The expected return is every possibility multiplied by the probability of the possibilities. The average of all the potential die rolls, which have equal probabilities, is $3.50.
290.    How much would you pay to play the same game with the option to roll again? If you only roll once you get that score, if you choose to roll again you get the score of the second roll.
i.    The price should be higher since given the option to roll again. Should only roll a second time if the first role is less than 3.5, the expected value, so only if you roll a 4, 5, or 6 would you roll again. Since the expected roll is 3.5, the latter three outcomes have expected returns of 3.5. So a game of two rolls’ expected return is (4+5+6+3.5+3.5+3.5)/6=$4.25
291.    Same game, but now option for third roll, how much will you pay.
i.    Two rolls have an expected return of 4.25 so will only roll a third time if you get above that. You have an expected return of (4.25+4.25+4.25+4.25+5+6)/6=$4.67. As the number of rolls approaches infinity, the price you pay gets closer to $6.
292.    You are given a length of rope, which can be lit to burn for an hour. The rope burns unevenly so half of it burnt does not indicate a half hour passed. How would you burn the rope to know that a half hour has passed?
i.    To measure a half hour, burn both ends at once. When they meet, half the time has passed.
293.    If you were given two ropes, how would you measure 45 minutes?
i.    Burn both ends of one rope at once, and at same time burn one end of the other rope. Once the two ends of the first rope meet, 30 minutes have passed, so then light other end of second rope. When they meet, 15 more minutes has passed.
294.    What is the probability of drawing two sevens in a card deck?
i.    Multiple the individual probabilities to get the cumulative probability. There are 4 sevens in a deck of 52 cards. So the probability of drawing the first 7 is 4/52 and the second 7 is 3/51, so the answer is 1/13*1/17=1/221.
295.    You’ve got a 10 x 10 x 10 cube made up of 1 x 1 x 1 smaller cubes. The outside of the larger cube is completely painted. On how many of the smaller cubes is there any paint?
i.    The larger cube is made up of 1,000 cubes. 8 x 8 x 8 inner cubes are not painted, which equals 512 cubes. Thus, 1,000-512=488 cubes that have some paint.
296.    What is the square root of 6,000,000?
i.    2*2=4 and 3*3=9, so between 2,000 and 3,000. Since 2.5×2.5=6.25 it is around 2,400.
297.    A closet has three light bulbs inside. Next to the door are three switches for each light bulb. If you can only enter the closet one time, how do you determine which switch controls which light bulb?
i.    Turn on two switches for a few minutes. Then turn one switch off, and enter the room. The light on corresponds to the switch that is still on, the light bulb that is still warm corresponds to the switch that was turned off, and the light bulb that is off and cold is controlled by the last switch.
298.    A lily in a pond doubles every minute. After an hour, the lily fills the entire pond. When is it 1/8 full?
i.    At 59 minutes, it is half full. At 58 minutes, its ¼ full. At 57 minutes, it is 1/8 full.
299.    What is larger 2^6 or 6^2?
i.    In most combinations, the lower number ^ higher number is higher because the higher exponential has a powerful multiplier effect, except 3^2 is higher than 2^3. Thus, 2^6 is higher.

300.  What is the square root of 2?

i. Try to figure this one out in your head without the aid of the calculator.  An exact answer is not necessary; 1.4 would suffice.

KKR & TPG Interested in Purchasing CICC Stake from Morgan Stanley

Monday, March 1st, 2010

Over the past three years, Morgan Stanley has had difficulty managing its stake in CICC or China International Capital Corp., one of China’s most prominent investment banks.  Recently both TPG and KKR, two of the most powerful private equity firms in the U.S. announced that they were interested in purchasing this stake from Morgan Stanley.  Other firms, including Bain and J.C. Flowers had showed interest in 2008, but valuations for too low at that point for Morgan Stanley to sell.  Morgan Stanley will now be able to start its own investment bank in China without having a conflict of interest.

According to Bloomberg’s Cathy Chan, ” TPG Capital LLP and Kohlberg Kravis Roberts & Co. are in final talks to buy Morgan Stanley’s stake in China International Capital Corp., the first Sino-foreign investment bank, for more than $1 billion, said four people with knowledge the matter.

The U.S. private equity firms plan to equally split Morgan Stanley’s 34.3 percent holding in CICC, the people said, asking not to be identified because the talks are confidential. Bain Capital LLC lost out in bidding for the stake after offering less than $1 billion, one person said.

Selling the stake will allow Morgan Stanley to build its own investment bank in China after being a shareholder in CICC for a decade without having management control. It’s the bank’s second attempt to dispose of the stake, after talks with buyout firms fell apart in early 2008 on disagreements about price. New York-based Morgan Stanley invested $35 million in CICC when it was established in 1995.

“It’s a good profit and Morgan Stanley has been seeking to build its own platform as they can’t exert influence on CICC,” said Liang Jing, a Shanghai-based analyst at Guotai Junan Securities Co. “For the buyout funds, it’s nice choice of investment if you don’t mind being a passive investor.”

Morgan Stanley ceded management control in 2000 and CICC is now run by Levin Zhu, the son of former Chinese Premier Zhu Rongji.

China Fortune

The Chinese government allowed Morgan Stanley to invest in CICC in return for the expertise required to build China’s first investment bank. Elaine La Roche, the last Morgan Stanley- appointed head of CICC, stepped down in June 2000. The partners bickered about compensation, management and strategy and that lack of consensus worked against both firms, she said in a 2005 interview.

Wei Christianson, Morgan Stanley’s chief executive officer in China, declined to comment, as did Joshua Goldman-Brown, an outside spokesman for KKR in Hong Kong, and officials at TPG. The Wall Street Journal and Financial Times earlier reported the two buyout firms are close to acquiring the CICC stake.

Morgan Stanley signed an initial agreement in 2007 to buy a one-third stake in China Fortune Securities Co. Regulators declined to sign off on that venture, partly because Morgan Stanley already owned a stake in CICC, people with knowledge of the matter have said.

“They have to start building the business from scratch and it will take five years before they can expand beyond underwriting business if they decide to be on their own,” Liang said.

Top Underwriter

The China Securities Regulatory Commission said late 2007 that overseas-invested financial firms that had been operating for five years would be allowed to expand into brokerage services.

CICC was last year’s top manager of Chinese domestic equity offerings, rising from No. 2 in 2008, according to data compiled by Bloomberg. Domestic equity and equity-linked sales in China rose to 245.6 billion yuan ($36 billion) in 2009 from 232 billion yuan a year earlier.

Buyout firms including TPG, Bain Capital, CV Starr & Co., J.C. Flowers & Co. and General Atlantic LLC showed interest in the CICC stake in 2008, people familiar said at the time.

Goldman Sachs Group Inc. was the first Wall Street investment bank to gain approval to form a securities venture in China in 2004, followed by UBS AG.

Credit Suisse Group AG and Deutsche Bank AG ventures won approval to underwrite bond and stock sales in 2008 and 2009 respectively, while Macquarie Group Ltd. is in the process of getting regulatory approval. CLSA Asia-Pacific Markets, the regional broking arm of Credit Agricole SA, formed its China venture in 2003.”


Skillsoft LBO

Sunday, February 14th, 2010


According to NewsCenter, “E-learning software maker SkillSoft Plc based in Ireland said it agreed to be acquired by a consortium of private-equity firms for about USD 1.1 billion, an offer that investors think undervalues the company.

The cash offer of USD 10.80 per share, made by funds owned by Berkshire Partners, Advent International and Bain Capital, was 11% more than SkillSoft’s closing price on Thursday. However, American depositary shares of the company edged past the offer to as high as USD 11.21, or up 15%, indicating that investors might be expecting a better offer.  As of Thursday’s close, the stock had dropped about 11% since touching a 52-week high of USD 10.99 in December, higher than the investor group’s offer.

‘We think we got the best price we could negotiate balancing a lot of the things that our board knows in terms of their understanding of the market,’ Chief Executive Chuck Moran said on a call with analysts.

The merger agreement has a ‘go-shop’ period, ending on March 6, that allows SkillSoft to scout for better offers.
However, the company said the board intends to recommend that shareholders vote in favour of the acquisition.

‘We would have hoped for a modestly higher price but business was challenging through this renewal period that they just completed,’ Craig-Hallum Capital analyst George Sutton told Reuters by phone.

‘The higher price would most likely come if there is a strategic buyer who can integrate the cost structure more effectively than a private equity firm.’

Signal Hill analyst Trace Urdan said possible strategic acquirers could include IBM and Accenture Plc.

Investment firm Columbia Wanger Asset Management is the largest stakeholder in SkillSoft with a 22% interest. The firm was not immediately available for comment.

Wedbush Securities analyst Ariel Sokol said in a note, ‘We wonder whether parties involved might have to increase the price of the company to mollify investors concerned that the company could potentially be sold a year too early.’

As of Thursday’s close, the company traded at a forward earnings multiple of 13 times and according to analysts the multiple could push to 16.5 times earnings. The offer values the company at 14.6 times 2010 earnings.


‘Characteristics of the training market have certainly shifted during this economic time. The growth rates have been reduced,’ CEO Moran said, adding that fiscal 2010 bookings were down from the prior year.

The company, which had revenue of USD 328 million for the year ended January 2009, provides Internet-based training courses and software to businesses and governments.

It competes with companies such as India’s NIIT, Kenexa and Blackboard Inc in the increasingly competitive e-learning software and services market.

The e-learning market accounts for a small part of the overall training market, and its growth has slowed in recent years due to the general economic slowdown and pricing pressures.

SkillSoft, whose customers include IBM, Merck, Toyota and Hilton, however, posted a higher-than-expected profit for the third quarter and raised its outlook for the year.

The company will continue to be headquartered in Dublin, Ireland, and led by the current management team, including Moran as CEO, it said.

The buyout will be financed with a USD 605 million financing package from Morgan Stanley and Barclays Capital, who are advising the investor group.”

~Sourced by I.S.

For more information, please visit NewsCenter…