Here are my notes on the sell-side M&A broker's activity. This was taken from Investment Banking: Valuation, Leveraged Buyouts and Mergers & Acquisitions by Joshua Rosenbaum and Joshua Pearl (Wiley, 2013, 988 pages)
An investment banker is also called an IB, i-banker, ibanker, or an M&A broker (mergers and acquisitions). In this page, I’ll use broker as the general term.
This webpage is part of my book Startup v.2.0.
The Role of the M&A Broker
The broker prepares your company to be sold, researches the market, writes reports on the market, identifies potential buyers, meets with them, finds the best offer, and closes the deal.
The brokers use their own research teams and they also buy research reports.
They also have a worldwide personal network of senior executives in their tar-get industries to get an insider’s view of the market.
The broker’s business analyst team researches the market for your startup. For example, if you’re building software for the automotive industry, they look into that market.
The broker’s analyst team write reports that starts with an understanding of your startup’s financials and potential. It looks at the state of the market: the players, companies, and customers. This includes how the market is structured, such as vendors, suppliers, sub-manufacturing, and distribution. They identify which companies are potential buyers (and which aren’t) by looking at the company’s position within a market and whether it is growing, stable, or de-clining.
They can estimate the impact to a company if it buys your company. This means how far would it place them ahead of their competitors in terms of rev-enues, transactions, markets, and so on. The projections can be anywhere from five years to twenty years.
The brokers use their personal networks to get personal introductions to the buyer team. They show the buyers why they should buy your company. This includes additional revenue, new products for their product line, access to new markets (either new categories or new territories), competitive advantage, and the impact on stock value.
This research is shown to potential buyers over a series of meetings to build in-terest and convince them to buy your startup. The brokers also pressure buyers on the need to move quickly and, if necessary, FOMO (fear of missing out).
An M&A deal can take nine months in a series of steps for research, reports, due diligence, meetings, bidding, and the closing transaction.
The large buyers also have their own research analysts who do the same re-search from their side. On some issues, they may agree and on other issues, they disagree. The heads of the buyer team look at their research and compare with your broker’s reports.
- M&A buy-side: help companies to acquire companies
- M&A sell-side: help companies be sold to companies
- Research analysts to understand the market, both sides (seller, buyer), and financial value. Analysts quantify the upside, downside, risks, and project the value. Generally in-house. Research the data and build financial models. Valuation, discounted cash flow analysis, net present value, future sales growth, costs, value of efficiencies, risk level, macroeconomics, etc. Sell-side offers a business plan to show the value of purchase.
- There are public analysts, but they may have hidden interests in suggestions to buy or sell. You must have your own research team.
- Goal of M&A is synergy: 1+1=3. The combination of companies may be greater than each alone. Grow faster. More market share allows stronger price competition. Enter new markets, enter foreign markets. C-level build empires to get more pay and bonus. If bigger, they earn more. Taxes: If buyer has too much profits, it can buy a company with big tax bill and thus have an overall lower tax bill.
- If buyer sees that a company is mismanaged, they can buy it and run it better to unlock value.
- If buyer finds a company with high assets but little debt, they can buy it and use the assets to borrow heavily to raise money for more deals. Bain did this to Toys-R-Us (and killed it with debt.)
- Horizonal merger: Buyer buys a company in the same space to get wider product offering, more market share, more revenue, target’s distribution chain, target’s team, economies of scale, competitive advantage. Lower production costs may lead to better profit margins.
- Vertical mergers: Vertical integration within the market. A manufacturer buys a supplier or retailer. Generally, this cuts costs (and removes a supplier from competitors), ensures supplies, ensures distribution, increase quality.
- Conglomerate mergers: companies in different markets are joined. By diversifying, they reduce risk in a downturn. They can also avoid seasonality. A winter company (ski boots) buys a summer company (surf boards) and seasonal revenue is smoother.
How to Research
- If the company is public, use EDGAR
- If private, look at industry publications, Websites, news reports, trends, third-party reports, reports about similar public companies, etc. about the company, industry, top persons
- Patent history, analysis of other patents and trends in the industry
- Personal contacts for insider information, evaluation, recommendations
- Buyers: Look for potential acquisitions (targets)
- Sellers: Look for potential acquirers (buyers)
- All public companies must file docs to SEC.gov EDGAR. Annual report is 10-K. look for business units with low growth, low revenues, etc. They will be interested in growth.
- Be extremely careful with information in social media. It can be deception or fraud.
- Look at macroeconomic indicators: unemployment, interest rates, production, inventory, consumer confidence, retail sales, inflation/deflation. Many of these are leading indicators for other trends.
- News from Bloomberg, Thomson-Reuters, Twitter, S&P Capital IQ.
- SECFilings.com will alert you to new relevant filings.
- Track M&A at MergerMarket.com, FaceSetMergers.com, DeaLogic.com
- S&P Dow Jones Indices shows profits trends for to 500 US companies.
- You can also track a hedge-fund manager. He must report all of his buy/sell activity
Best Information Resources
- Standard & Poor’s
- Renaissance Capital
- Index Fund Advisors (IFA.com)
- Morning Star
- Bureau of Labor Statistics,
- Dept. of Commerce
- Federal Reserve
Examples of M&A Fraud
The sale of a company includes the transfer of a great deal of money and stock, plus commissions and fees which can be tens of millions or even hundreds of millions of dollars. This creates a strong incentive for fraud. Here are examples of M&A fraud.
- If information can affect the stock, it is material. If someone wants non-public material information in order to buy/sell stock, that is insider trading. Upcoming M&A, changes in management, regulatory approval or rejection, patents, earnings numbers.
- Pump and Dump. Boiler rooms. Short selling to drive down the market. Spread false rumors. Churning by market makers.
- During the dotcom boom, Wall Street analysts were publishing fake reports to encourage sale of stock. They paid $875m in penalties.
- Dotcom Boom: Brokers used greater fools, stampede, and FOMO to sell industries that nobody understood, etc.
- Sunbeam showed strong revenue because they booked revenues when they sent an invoice but didn’t ship products. They billed for gas grills in November which wouldn’t be shipped or sold before May. Analysts discovered inventory rose 59% and accounts receivables increased 39% over previous year.
- Some companies place cash in various places (investments, loans, deposits, Bahamas, etc.) so it’s difficult to review. They overstate cash assets.
- Company’s gold mine has estimated $100M in gold. It takes out $10m annually so asset value drops by $10M which it should declare as a shrinking asset. But if it doesn’t, the company has greater asset value.
- WorldCom.com stated expenses as investments. Investors think this will produce additional future revenue. It was renting a house but declaring rent payments as equity payments and so investors thought it would eventually own the house as an asset. (startup pays rent but declares it as equity) Forensic accountants compared Worldcom’s data against similar companies and saw the discrepancy.
- Enron’s valuation was 55X earnings. It was Fortune Magazine’s Most Innovative Company of the Year for six years because nobody could figure out the massive and complex accounting fraud and everyone wanted to believe.
- Olympus created sub-companies (SPE: Special Purpose Entity) and sold loser projects to SPEs at full value and booked the revenue to hide $1B in losses over 20 years.
- A company set up consulting companies, paid huge consulting fees, and in effect outflowed the assets from the company to the C-board.
- CDS: Credit Default Swaps. Company A buys insurance on company B’s deals. If B defaults, A gets insurance money. Insurance companies were happy to sell insurance on industries where default was low (e.g., home mortgages). They laughed at the idiots because it was free money. But… mortgage brokers made $5,000 per mortgage so they sold sub-prime mortgages to dogs, took the $5,000, and the bad mortgages were bundled and sold as securities with high yields. Investors expected normal defaults 2%, but these were junk borrowers, so the mortgage bonds evaporated and the insurance companies had to pay out billions.
- Credit Suisse swindled startups at IPO by offering large blocks of shares at low prices to favored customers who had to return 30-66% of the profits to Credit Suisse. Startups lost tens of millions of dollars.
Lessons for Analysts
- The M&A broker relies on analyst reports. Companies want to present the best picture, so data can be fake or mislead and analysts must be skeptical detectives.
- The M&A broker's analytics are often forensic accounting analysts who look skeptically at reports, data, and compare with other companies and industry trends to figure out the real story.
- Verify. Be extremely skeptical. Compare all data against similar companies. Talk with others. Assume it’s all fraud and lies.
- If it sounds too good, it’s fake. Few outliers. Regression to the mean.
- Don’t invest in anything you don’t understand.
Questions to Ask
- Who are the players in this industry? What personalities are involved, either as corporate entities, or the specific people involved?
- What are their inputs and outputs? What's going on in those markets? Is the secular trend in market participants growing or shrinking? How about market size? How about supply constraints?
- When are they chronologically weak or strong? Are there cross-industry dynamics in time that matter? How about intra-industry? Any regulatory changes on the horizon?
- Where do these players operate? What's going on in those localities?
- Why have these players chosen the courses of action that they did? Is there evidence that the criteria they chose to set their direction are the right ones? Do you agree with their professed rationales?
- How do these players view themselves and their peers? How are they viewed by other powerful actors that matter?
- The important thing is this: have an opinion. Whether you are right or wrong matters less than that you express a point of view that engenders a thoughtful conversation with the folks who will commit risk dollars.