Strategic Management & the Investment Banker
Investment Bankers & Strategic Alternatives
Investment bankers identify the business opportunities that can generate the most attractive equity valuations and implement strategic plans to capitalize on those prospects. Determine strategic alternatives with management after discussing market (m&a, financing, value chain of industry, where ROA is coming from, what the equity markets are rewarding with higher multiple)
Then model the strategic alternatives in excel
involving an investment bank in an organization’s strategic planning process
When the time is right to execute on a strategic or financial transaction, an investment bank serves as a strong advocate for the client during the transaction marketing process.
An investment bank can help shape a company’s strategic plan
Using feedback from strategic and financial investors, a firm can direct its efforts to exploring business opportunities that are viewed favorably by the investment community and strategic investors. This approach to long range strategic planning can yield significant valuation gains over time.
allow a firm to sell opportunistically when the market is robust and, conversely, buy when the market experiences softness. Without an investment bank’s input into a firm’s strategic plans, the likelihood of mis-timing the market and underperforming increases greatly.
Senior executives should make contact with their chosen senior investment banker at least once a quarter. Discussion topics during this update session may include operational developments and strategic initiatives, financial results, and market intelligence on the strategic wish list as well as broader investment objectives. Ideally, conducting this discussion in advance of any board meetings will ensure that a company is fully apprised of any new developments in the marketplace and can develop strategies that incorporate them.
Conducting an annual review of the firm’s strategic alternatives with an investment bank can yield new insights. By reviewing a firm’s strategic alternatives with respect to capital raising, partnership opportunities, and shareholder liquidity options, the company can chart a course for the long term. With the feedback from this review as a backdrop, a firm can kick-off its internal strategic planning process and create a framework for optimizing the company’s resources and opportunities for the coming year.
Strategic alternatives pitch. Student teams develop a bank-quality strategic alternatives pitch and deliver their recommendations to the CFO or head of strategy of a firm.
The breakdown of your index into separate indices for subsector allows you to build your value chain for the industry and highlight what the equity markets are rewarding, where ROA is coming from.
Evaluating Strategic Alternatives
Most companies, particularly well-managed businesses, have multiple strategic options available for both liquidity and growth. Evaluating Strategic Alternatives (ESA) is a formal review, analysis, and decision-making process that guides owners in assessing their financial and strategic options. The ESA process helps owners clarify and prioritize their personal and business objectives based on their company’s strategic direction, financial characteristics, and shareholder liquidity preferences.
Whether an owner’s goal is to expand the business, or to pursue a value-optimizing exit strategy, our investment banking team’s ESA assessment provides an objective, market-based valuation, as well as the options to achieve the value, and the implications of each option for the owner. The output from an ESA assessment includes a framework for strategic and operational decision-making; alignment between the owner’s long-term business objectives and the needs of the management team and shareholders; optimization of wealth transfer between shareholders; and coordinated tax structuring and exit planning strategies.
Essentially, investment bankers determine the valuation of the company under a number of strategic alternatives using comp companies, precedent transactions, DCF, LBO analysis and Merger analysis. The investment bank is usually asked by a company or pitches the prospect of reviewing strategic alternatives for the company.
The first step is to determine valuation (football field) under different scenarios including as is, change in capital structure, and sale to a strategic or financial buyer. The max valuation is then communicated as a recommendation to the Board of Directors of the company. The investment banker then recommends a process to be run by the investment bank in order to execute on the strategic alternative.
Strategic plan (industry value chain optimized financial statement model with scenarios + valuation), strategic goals, corporate projects, executing corporate projects (business case development, project proposal, selection), tracking project benefits individually and in aggregate in relation to strategic plan
A strategic plan links the vision and the mission to the economic reality of the business expressed in a financial statement model. The schedule for revenues is broken down by segments which is broken down further by corporate projects (that have been accepted).
Strategy is how you plan to add monetary value from a valuation perspective
Strategic plan is where you are (historicals and current valuation), where you want to be (from a multiples perspective and EBITDA), and then building backwards from then until now.
Business level strategy is how do we compete in a distinct business
Corporate strategy is how do we bring the businesses together in a way that adds value?
Business strategy is where projects/programs emanate.
Industries change in attractiveness in terms of profitability at any given time
What is the average ROI/ROA in the industry? Is your perpetuity above or below this?
In order to beat the average, must have a competitive advantage
Part of performance has to do with the industry. Part of the performance has to do with are you better or worse than the competition (positioning)
5 forces acting on the corporate arbitrage to weaken it
Industry analysis to understand ROA of the industry given an index of public comps that you are maintaining
Second is positioning, higher price with positioning or lower cost to improve ROA
Are you a premium priced differentiator or a cost leader with an acceptable product
Positioning will relate to an analysis of the value chain. Where are ROAs at each step of the value chain?
Every business has a value chain and the early company must build out its value chain
All competitive advantage comes from the value chain
Where does competitive advantage come from in the value chain?
Projects/programs connected to some part of the value chain
Operate at best practice through each step of the value chain
Managers must identify best practice, validate them, then do them
Operationally effective means assimilating best practices
How to configure the value chain to deliver on the value proposition (differentiation) that your competitors cannot
Strategy is configuration of the value chain in a differentiated way past best practice. Pioneering new best practices
Best practices are founded by projects and programs
financial plan is budgeted financial statements
Investments must at least earn the cost of capital. If investments earn above cost of capital, market value will increase. If investments earn lower, market value will decrease
Capital markets can be broken down into primary markets and secondary markets. Primary markets are those markets where new issues of securities are sold. Secondary markets are where outstanding securities are traded (such as the New York Stock Exchange).
strategic planning is a way of preparing for the future by attempting to simulate the future via financial statement models
Strategic planning: Analyze current capabilities in the industry value chain and ROIs on each step in value chain. Analyze industry value chain average ROIs and compare. What capabilities in industry value chain to build next to increase ROI?
This marks strategic goals; will they be accomplished organically or inorganically?
These strategic goals should be included in the FSM&V to show the impact on value.
Vision and mission statement before strategic goals
- Determine position (industry value chain & ROIs)
- Develop strategy (grow current capabilities, acquire/build new in order to organize firm value chain in a differentiated way)
- Develop plan to acquire/build capability along with FSM
- Implement the plan
- Measure against the plan actual results
Strategic Alternatives & Strategic Management Process:
Strategic Analysis & Choice
Strategy choice involves the evaluation of alternative strategies and selecting the best one. It involves the following steps:
- Focusing on strategic alternatives
- Involves the identification of alternatives. The strategist examines what the organization wants to achieve (desired performance) and what it has really achieved (actual performance). The gap between the two is the background for various alternatives (gap analysis). The gap can be filled via the industry value chain and either deepening activities in an existing part of the industry value chain or entering a new part of the industry value chain.
- Evaluating strategic alternatives
- Involves the modeling of the strategic alternative in a financial statement model in excel. Corporate scenario analysis means creating pro forma balance sheets and income statement to forecast the strategic alternative’s impact.
- Strategic choice
When doing a strategic analysis via financial planning & analysis within a corporation, we are going to model pro forma financial statements based upon historical assumptions carried forward into the future. This is going to give us an understanding of where we will be if we do nothing differently. We can then identify where we would like to be from a valuation perspective and then go about identifying strategic alternatives that can fill the gap between where we are now and where we want to be.
Plans, Programs & Projects
The strategic plan devised by the organization proposes the manner in which the strategies will be put into action. Strategies are accompanied by the implementation of tools including plans, programs, and projects. The strategy itself will be broken down into different plans to chunk the work. Within the plans, there are various programs to chunk the work further into smaller components. Programs then lead to the formulation of projects. A project possesses a time schedule and costs (budget) and requires the allocation of funds based upon capital budgeting by organizations. Projects require resources inputs and systems.
The Purpose of the Company
Companies exist to create value
How Companies Create Value
Companies create value by investing capital at rates of return that exceed their cost of capital. This is the principle of value creation.
The only thing that differs across companies is the implementation (i.e. different asset and capitalization mix)
Strategy & Finance
The Role of the CEO
Perpetuity Management with Discounted Cash Flows
Growth or Restructuring
Perpetuity Management Process
Measuring Value Added: ROIC vs. Market Return
Measure return on invested capital (after-tax operating profits divided by capital invested in working capital, PP&E) and compare it with stock market returns
Measuring Value Added: Economic Profit & NPV
Economic profit = ROIC spread % over cost of capital x invested capital
The objective is to maximize economic profit. When the company is larger, one should use Net Present Value (NPV) which calculates economic profit in a more robust and flexible fashion.
Valuation in the Public Markets
Valuation in the public markets has investors paying for the performance they expect the company to achieve in the future; investors ultimately end up paying more since their valuations are not based upon the past or cost of the assets.
The CEO should endeavor to have his company in the public markets since the largest multiples are applied in valuation
Real Markets & Financial Markets
When a public company, the CEO has to both maximize the intrinsic (DCF) value of the company and manage the expectations of the financial market
Differences between actual performance and market expectations and changes in these expectations drive share prices. The delivery of surprises produces higher or lower total shareholder returns
Perpetuity Planning & Control (i.e. Management)
Planning & control system should be put in place to monitor the NPV of every business unit and summed to get the NPV of the corporation. Economic profit (i.e. NPV) targets set annually for next three years, progress monitored monthly and managers’ compensation tied to economic profit against these targets
Metrics are to drive decisions and guide all employees toward value creation.
Perpetuity Planning & Control (i.e. Management) in Practice
Corporate management sets long-term value creation targets in terms of market value of a company or total returns to shareholders (TRS)
Strategic alternatives valued in DCF (i.e. NPV)
Intrinsic value of chosen strategic alternative translated into short and medium term financial targets and then targets for operating and strategic value drivers
Performance assessed by comparing results with targets on both financial indicators and key value drivers. Managerial rewards linked to performance on financial measures and key value drivers
Value Metrics: Market Value Added & Total Return to Shareholders
Market Value Added is the difference between the market value of a company’s debt and equity and the amount of capital invested. Measures financial market’s view of future performance relative to capital invested in business.
Total Return to Shareholders measure performance against the expectations of financial markets and changes in these expectations. TRS measures how well a company betas the target set by market expectations
Value Metrics: DCF vs. Earnings Multiple
DCF is intrinsic value. Earnings multiples are market values.
Earnings alone is inadequate without understanding the investment required to generate the earnings. Should know ROIC
Cash flow equals the operating profits of the company less the net investment in working capital and fixed assets to support the company’s growth.
Perpetuity Management Capability
- Analyze where perpetuity is currently at (which phase)
- Determine which phase is the goal
- Determine steps to get to next phase of the perpetuity
- Build Work Breakdown Structure (WBS) to get to next phase working backward from the next phase
- Execute the plan