Giddy/Bouygues Capital Markets & New Economy 1
U.S. Capital Marketsand
Corporate Finance
Prof Ian GiddyNew York University
NYU/Bouygues
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 3
Three Issues inGlobal Corporate Financing
l Financing European and American Enterprisesu The New European Capital Marketu Capital markets in USA and Asiau Venture Capital and Corporate Venturing
l Shareholder Value and the "Cost of Capital"u Why shareholder value mattersu Why the “cost of capital” matters
l Mergers, Acquisitions and Divestituresu How the market values acquisitions and divestituresu Where the money comes from
Giddy/Bouygues Capital Markets & New Economy 2
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 4
Managing Corporate Finance
BankFinancing
BankFinancing
Risk ManagementInstruments
Risk ManagementInstruments
CapitalMarkets
CapitalMarkets
Corporate FinanceNeeds
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 5
Three Issues inGlobal Corporate Financing
l Financing European and American Enterprisesu The New European Capital Marketu Capital markets in USA and Asiau Venture Capital and Corporate Venturing
l Shareholder Value and the "Cost of Capital"u Why shareholder value mattersu Why the “cost of capital” matters
l Mergers, Acquisitions and Divestituresu How the market values acquisitions and divestituresu Where the money comes from
Giddy/Bouygues Capital Markets & New Economy 3
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 7
Banking and Capital Markets:Europe vs. USA
l Banks vs. Marketsl Relationships vs. Transactionsl On Balance Sheet vs. Offl Domestic vs. Regional vs. Globall Debt vs. Equityl Bricks vs. Bytes
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 8
Banks vs. Markets
l Where are investors going?l What do today’s shareholders expect?l Where are corporations going?l Where is your banker going?
l Common theme: “The end ofentitlement” (which implies the end ofspecial responsibilities)
Giddy/Bouygues Capital Markets & New Economy 4
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 9
Relationships vs. Transactions
l Lower barriers to entry – more pricecompetition
l Frequent re-calculation of benefits: “What willyou do for me next?”
l Shareholder pressure weakens traditionalrelationships, obligations
l In business, the effect is toward alliances,contract manufacturing, out-sourcing
l Stability requires “new communities,” themore broadly-based the better
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 10
Financial Innovationand the Shorter Product Life Cycle
l More financial innovationl But most innovations faill Fewer geographic barriers to entryl Fewer information barriers to entry
Excessreturns
Time
Giddy/Bouygues Capital Markets & New Economy 5
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 11
Innovation as Value Creation
l Innovations are costly to develop andproduce, and easily copied, so
l For an innovation to succeed, it mustcreate differentiated value for issuer,investor, or risk manager, by:uUnbundling: create simple, more primitive
instruments to isolate risks, or
uBundling: create tailor-made instrumentsto reduce costs, minimize taxes, orcircumvent restrictions or imperfections.
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 12
On Balance Sheet vs. Off
l “All my assets are for sale, all the time”l Maximize ROE by increasing capital
turnover – become originators insteadof lenders
5,4 5,71,6
5,39,1 6,9
33,135,4
38,8
61,7
0,0
10,0
20,0
30,0
40,0
50,0
60,0
70,0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999(YTD)
Market value of transactions in Europe (1990-present) Euro bn
Asset-BackedSecurities
Asset-BackedSecurities
Giddy/Bouygues Capital Markets & New Economy 6
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 13
Domestic, Regional or Global?
l Which are more mobile?uGoods markets
uLabor
uServices
uFinancial services
l Even domestic institutions must be ableto compete in the world arena
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 14
Debt vs. Equity
0.1
1
10
100
1000
10000
1925 1935 1945 1955 1965 1975 1985 1995
Index ($)
$4,495.99
$33.73
$13.54$8.85
$1,370.95
Small CompanyStocks
LargeCompanyStocks
Long-TermGovernmentBonds
Treasury BillsInflation Year-End
A $1Investmentin DifferentTypes ofPortfolios:1926-1996
Giddy/Bouygues Capital Markets & New Economy 7
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 15
Passive vs. Active Investors
l It’s an internet information agel Domestic shareholders want global
returns – asset managers must beatbenchmarks
l Corporations or financial institutionswhich cling to underperforming assetswill have lower ROE and share prices
l Which makes them vulnerable torestructuring or takeover – Europe’snew market for corporate control
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 16
Passive vs. Active Investors
uInvestors expect results or sell their shares;“friendly holdings” become too costly,opportunity costs become explicit
uVenture capital, private equity funds attractinvestors by offering higher returns
uMarket-based returns now expected byinvestors and lenders, and required ofmanagers; local differences persist, butdiminishing
Giddy/Bouygues Capital Markets & New Economy 8
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 17
Bricks vs. Bytes
l It’s a Nasdaq world, and it’s moving at“internet time”
l The old economy needs the neweconomy to meet shareholderexpectations
“To B2B, or not to be?”l E-business or m-business?l Equity, not debt, is financing the new
economy
Check your ownbank’s onlineand mobilefinancial services
Check your ownbank’s onlineand mobilefinancial services
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 18
Whither European Financial Services?
l The Anglo-Saxon model of transparentfinancial markets is coming, at internetspeed
l All assets must meet the test of themarket – global shareholder returnstandards
l Otherwise…
Giddy/Bouygues Capital Markets & New Economy 9
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 19
Example: Deutsche-Dresdner
l What is Deutsche’s strategy?l Does the Dresdner acquisition advance
that strategy?l What does it take to succeed in
investment banking?
Deutsche-Dresdner case study
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 20
The Commercial Banking Model
Assets Liabilities
Loansn Net interest
revenues
Loansn Net interest
revenues
Depositsn Net interest
costs
Depositsn Net interest
costs
Goal: Add assets with positive net interest margin
Giddy/Bouygues Capital Markets & New Economy 10
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 21
The Investment Banking Model
Sales
CapitalMarkets
CorporateFinance
Customer-DrivenSecurities
Goal: Originate deals and sell them in the capital marketas quickly as possible
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 22
The Asian Bet
l High growth disguised speculativefinancing structures
l Governments shielded companies andbanks from capital market discipline
l Too much debtl Too much foreign-currency debtl Closely held ownership relying on
reinvested earnings
Giddy/Bouygues Capital Markets & New Economy 11
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 23
The Asian Bet
l High growth disguised speculativefinancing structures
l Governments shielded companies andbanks from capital market discipline
l Too much debtl Too much foreign-currency debtl Closely held ownership relying on
reinvested earnings
The three excessesn Too much debtn Too much laborn Too much capacity
The three excessesn Too much debtn Too much laborn Too much capacity
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 24
Corporate Finance
CORPORATE FINANCEDECISONS
CORPORATE FINANCEDECISONS
INVESTMENTINVESTMENT RISK MGTRISK MGTFINANCINGFINANCING
CAPITAL
PORTFOLIO
M&ADEBT EQUITY
TOOLS
MEASUREMENT
Giddy/Bouygues Capital Markets & New Economy 12
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 25
The CFO Questions
l How fast can we grow? What criteria forspending money? Acquisitions? Divestitures?
l How should we finance our growth? What kindof equity?
l How much (cheap) debt should we have?
l What kind of debt should we have? Maturity?Fixed/floating? Currency? Asset-backed?Hybrids, such as convertibles?
l How should we manage our financial risks?
l What’s our plan for creating shareholder value?
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 26
Corporate Financing Life-Cycle
Growth companies Mature companies
Leverage
Giddy/Bouygues Capital Markets & New Economy 13
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 27
Firm Characteristics as GrowthChanges
Variable High Growth Firms tend to Stable Growth Firms tend toRisk be above-average risk be average risk
Dividend Payout pay little or no dividends pay high dividends
Net Cap Ex have high net cap ex have low net cap ex
Return on Capital earn high ROC (excess return) earn ROC closer to WACC
Leverage have little or no debt higher leverage
Earnings
Gearing
0
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 28
Three Issues inGlobal Corporate Financing
l Financing European and American Enterprisesu The New European Capital Marketu Capital markets in USA and Asiau Venture Capital and Corporate Venturing
l Shareholder Value and the "Cost of Capital"u Why shareholder value mattersu Why the “cost of capital” matters
l Mergers, Acquisitions and Divestituresu How the market values acquisitions and divestituresu Where the money comes from
Giddy/Bouygues Capital Markets & New Economy 14
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 29
The Goal of Financial Management
l What are firm decision-makers hired to do?“General Motors is not in the business of making
automobiles. General Motors is in the business ofmaking money.”
Alfred P. Sloan
l Possible goals: Size, market share, profits
l Three equivalent goals of financialmanagement:uMaximize shareholder wealthuMaximize share priceuMaximize firm value
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 30
The Goal of Financial Management
Value-based management drives our performance
targets and incentives. We have set
ambitious short and medium-term financial
and operating targets and, to help meet
these, have aligned the interests of
management and employees with those of our
shareholders and customers. Our incentive
systems are linked to key aspects of
shareholder value, such as margins and
asset productivity. Our strategic focus is
centred on profitable growth, better
margins through innovation and higher
productivity, improved asset management,
and turnarounds in operations whose past
performance has not been world class.
Onecompany’sstatement
Giddy/Bouygues Capital Markets & New Economy 15
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 31
First Principles of CreatingShareholder Valuel Invest in projects that yield a return greater than the minimum
acceptable hurdle rate.u The hurdle rate should be higher for riskier projects and reflect the
financing mix used - owners’ funds (equity) or borrowed money(debt)
u Returns on projects should be measured based on cash flowsgenerated and the timing of these cash flows; they should alsoconsider both positive and negative side effects of these projects.
l Choose a financing mix that minimizes the hurdle rate andmatches the assets being financed.
l If there are not enough investments that earn the hurdle rate,return the cash to stockholders.u The form of returns - dividends and stock buybacks - will depend
upon the stockholders’ characteristics
l Minimize unnecessary financial risks.
Objective: Maximize the Value of the Firm
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 32
The Classical Objective Function
STOCKHOLDERS
Maximizestockholderwealth
Hire & fire managers- Board- Annual Meeting
BONDHOLDERS
LendMoney
ProtectbondholderInterests
FINANCIAL MARKETS
SOCIETYManagers
Reveal informationhonestly and on time
Markets are efficient and assesseffect on value
No SocialCosts
Costs can betraced to firm
Giddy/Bouygues Capital Markets & New Economy 16
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 33
What Can Go Wrong?
STOCKHOLDERS
Managers puttheir interests overshareholders’
Have little controlover managers
BONDHOLDERS
LendMoney
Bondholderscan getripped off
FINANCIAL MARKETS
SOCIETYManagers
Delay bad news orprovide misleadinginformation
Markets makemistakes and canoverreact
SignificantSocial Costs
Some costscannot betraced to firm
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 34
A Contrast: Disney vs. Campbell Soup
BEST PRACTICES CAMPBELL SOUP DISNEYMajority of outside directors Only one insider 7 of 17 members
among 15 directors are insiders
Bans insiders on nominating Yes No: CEO is
committee chairman of panel
Bans former execs from board Yes No
Mandatory retirement age 70, with none None
over 64
Outside directors meet w/o CEO Annually Never
Appointment of 'lead director'' Yes No
Governance committee Yes No
Self-evaluation of effectiveness Every two years NoneDirector pensions None Yes
Share-ownership requirement 3,000 shares None
Giddy/Bouygues Capital Markets & New Economy 17
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 35
Overpaying on Takeovers
l The quickest and perhaps the most decisive way toimpoverish stockholders is to overpay on a takeover.
l The stockholders in acquiring firms do not seem toshare the enthusiasm of the managers in these firms.Stock prices of bidding firms decline on the takeoverannouncements a significant proportion of the time.
l Many mergers do not work, as evidenced by anumber of measures.u The profitability of merged firms relative to their peer groups,
does not increase significantly after mergers.u An even more damning indictment is that a large number of
mergers are reversed within a few years, which is a clearadmission that the acquisitions did not work.
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 36
What’s a Company Worthto Another Company?
l Required Returnsl Types of ModelsuBalance sheet modelsuDividend discount & corporate cash flow
modelsuPrice/Earnings ratiosuOption models
l Estimating Growth Ratesl Application: How These Change with
M&A
BouyguesBouygues
Giddy/Bouygues Capital Markets & New Economy 18
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 37
Equity Valuation:From the Balance Sheet
Value of Assetsn Bookn Liquidationn Replacement
Value ofLiabilities
n Bookn Market
Value of Equity
BouyguesBouygues
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 38
Relative Valuation
l Do valuation ratios make sense?• Price/Earnings (P/E) ratios
q and variants (EBIT multiples, EBITDAmultiples, Cash Flow multiples)
• Price/Book (P/BV) ratiosq and variants (Tobin's Q)
• Price/Sales ratios
l It depends on how they are used -- andwhat’s behind them!
Giddy/Bouygues Capital Markets & New Economy 19
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 39
Valuing a Firm with DCF:An Illustration
Historicalfinancialresults
Adjust fornonrecurringaspects
Gaugefuturegrowth
Adjust fornoncashitems
Projected salesand operatingprofits
Projected free cash flowsto the firm (FCFF)
Year 1FCFF
Year 2FCFF
Year 3FCFF
Year 4FCFF
Terminal year FCFF
Stable growth modelor P/E comparable
Presentvalue of freecash flows
+ cash,securities &excess assets
- Marketvalue ofdebt
Value ofshareholdersequity
…
Discount to present using weightedaverage cost of capital (WACC)
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 40
More Simply, Invest Only When
Returnon
Assets
Cost ofFinancingexceeds
Giddy/Bouygues Capital Markets & New Economy 20
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 41
Three Issues inGlobal Corporate Financing
l Financing European and American Enterprisesu The New European Capital Marketu Capital markets in USA and Asiau Venture Capital and Corporate Venturing
l Shareholder Value and the "Cost of Capital"u Why shareholder value mattersu Why the “cost of capital” matters
l Mergers, Acquisitions and Divestituresu How the market values acquisitions and divestituresu Where the money comes from
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 42
Goals of Acquisitions
Rationale: Firm A should merge with Firm B if[Value of AB > Value of A + Value of B + Cost
of transaction]l Synergyl Gain market powerl Disciplinel Taxesl Financing
Giddy/Bouygues Capital Markets & New Economy 21
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 43
Fallacies of Acquisitions
l Size (shareholders would rather havetheir money back, eg Credit Lyonnais)
l Downstream/upstream integration(internal transfer at nonmarket prices,eg Dow/Conoco, Aramco/Texaco)
l Diversification into unrelated industries(Kodak/Sterling Drug)
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 44
Do Acquisitions Benefit Shareholders?Successful Bids
Technique Target Bidders
Tender offer 30% 4%Merger 20% 0Proxy contest 8% na
n Note: Abnormal price changes are price changes adjusted toeliminate the effects of marketwide price changes
Giddy/Bouygues Capital Markets & New Economy 22
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 45
Do Acquisitions Benefit Shareholders?Unsuccessful Bids
Technique Target Bidders
Tender offer -3% -1%Merger -3% -5%Proxy contest 8% na
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 46
The Price: Who Gets What?
Daimler Chrysler Combined
Market value before dealleaked
$52.8 $29.4 $82.2
Value added by merger $18.0
Merged Value $100.2
Shareholders get 57.2% 42.8% 100%
Which is now worth $57.3 $42.9 $100.2
Shareholders' shares ofthe gain
$4.5 $13.5 $18
Premium, as % 9% 46%
Giddy/Bouygues Capital Markets & New Economy 23
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 47
When Shareholders GainFrom an Acquisition
Gains from merger
Synergies Control
Top line Financialrestructuring
BusinessRestructuring
(M&A)
Bottom line
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 48
What is Corporate Restructuring?
l Any substantial change in a company’sfinancial structure, or ownership orcontrol, or business portfolio.
l Designed to increase the value of thefirm
Restructuring
Improvecapitalization
Change ownershipand control
Improvedebt composition
Giddy/Bouygues Capital Markets & New Economy 24
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 49
It’s All About Value
l How can corporate and financialrestructuring create value?
Operating
Cash
Flows
Debt
Equity
Assets Liabilities
Fix thebusiness
Or fix thefinancing
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 50
Restructuring
What mix of debt is best suited tothis business?
Fix the kind of debt or hybridfinancing
What can be done to make theequity more valuable to investors?
Fix the kind of equity
Value the changes new controlwould produce
Fix management or control
Revalue firm under differentleverage assumptions – lowestWACC
Fix the financing – improve D/Estructure
Value the merged firm withsynergies
Fix the business – strategic partneror merger
Value assets to be soldFix the business mix – divestitures
Use valuation model – present valueof free cash flows
Figure out what the business isworth now
Giddy/Bouygues Capital Markets & New Economy 25
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 51
Getting the Financing RightStep 1: The Proportion of Equity & Debt
Debt
Equity
n Achieve lowestweighted averagecost of capital
n May also affect thebusiness side
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 52
Getting the Financing RightStep 2: The Kind of Equity & Debt
Debt
Equity
n Short term? Long term?n Baht? Dollar? Yen?
n Short term? Long term?n Baht? Dollar? Yen?
n Bonds? Asset-backed?n Convertibles? Hybrids?
n Bonds? Asset-backed?n Convertibles? Hybrids?
n Debt/Equity Swaps?n Private? Public?n Strategic partner?n Domestic? ADRs?
n Debt/Equity Swaps?n Private? Public?n Strategic partner?n Domestic? ADRs?
n Ownership & control?n Ownership & control?
Giddy/Bouygues Capital Markets & New Economy 26
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 53
The CFO Questions at Bouygues
l How fast can we grow? What criteria forspending money? Acquisitions? Divestitures?
l How should we finance our growth? What kindof equity?
l How much (cheap) debt should we have?
l What kind of debt should we have? Maturity?Fixed/floating? Currency? Asset-backed?Hybrids, such as convertibles?
l How should we manage our financial risks?
l What’s our plan for creating shareholder value?
Copyright ©2000 Ian H. Giddy www.giddy.org U.S. Capital Markets and the New Economy 57
Ian H. Giddy
Stern School of Business
New York University
44 West 4th Street, New York, NY 10012, USA
Tel 212-998-0332; Fax 917-463-7629
http://giddy.org