Seminar Series : Introduction to Investment Banking & Competitive Strategy

1. Seminar Series: Introduction to Investment Banking & Competitive Strategy Created by Harry Radburn Investment Banking and Investment Management Coordinator University of Hertfordshire Trading & Investment Society 2013/14

2. What is an investment bank? • Financial services institution that provides a variety of services: • Mergers & acquisitions (M&A) advisory • Underwriting • Consulting services • Structured finance solutions • Prime brokerage (Sales & Trading) • Asset Management • Do not confuse with retail banking which involves providing deposit services; though they may be part of the same company.

3. Who are they? YTD 2013: • Just these 10 large investment banks earn over $78 billion in fees from various activities, there are also a range of small-medium or ‘boutique’ investment banks. • 2013 saw a period of strong growth throughout the industry with the top 4 firms all experiencing double-digit growth. Source: Financial Times 2013 (Online), available on: http://markets.ft.com/investmentBanking/tablesAndTrends.asp

4. Where are they? YTD 2013: • The Americas were (obviously) the leading market for deals in 2013, with Europe a distant second. • The growth rates of deals in developed economies are generally encouraging. Source: Financial Times 2013 (Online), available on: http://markets.ft.com/investmentBanking/tablesAndTrends.asp

5. Who are they working with? YTD 2013: Source: Financial Times 2013 (Online), available on: http://markets.ft.com/investmentBanking/tablesAndTrends.asp • This table and chart demonstrate the industries with the highest intensity of deals across all classes of operation. • Highest activity in industries that are extremely competitive and require high financial agility.

6. What do they actuallydo? M&A • When one company wishes to purchase another company or its assets, or merge with another company, investment bankers manage the process of doing so, this includes: • Investigating the target business and compiling a report for the acquirer conveying the positive and negative aspects of the target company and its industry (due diligence). • Calculating an appropriate price, and method, of acquisition i.e. cash, stock swap or debt funded acquisition. • Ensuring the transaction is completed smoothly through communicating with both sets of executive managers (Chairman, CEO, and CFO etc..).

7. Underwriting • One method companies can use to raise capital is through an equity offering. • An IPO (initial public offering) is the first issuance a company uses to sell shares to the investing community on a stock market. • Subsequent secondary equity issuances can be executed in order to raise further capital. • The lead investment bank (usually more than one are involved in the process) will calculate an appropriate price for the shares to be issued using the companies financial statements and by investigating the companies assets and business operations. • The investment banks are also responsible for generating investor interest in the issuance through road shows and existing investor contacts. • This area can be explored more through various Corporate Finance texts and articles – speak to a committee member afterwards for more info.

8. Consulting • Investment Bankers also consult executive managers in developing strategies for a variety of corporate activity. • This role, Management Consultancy, is competed for by other investment banks, and large non-banking firms such as: Ernst & Young, Deloitte, PwC, and KPMG. • The key principle of the consulting business is helping managers make the best decisions at the right time. Ensuring that their strategy is appropriate, competitive, and conducive to growth.

9. StructuredFinance • Involves securitising assets into units that are then sold to investors to create a market. These combinations can be offered in ‘tranches’ in order to separate into different values of risk & reward. • Two types of such structured products are: Collateralised Debt Obligations (CDO’s) and Asset-Backed Securities (ABS’s). • CDO’s can include mortgage debt, student loans, and car loans. They are, in part, attributed to causing the financial crisis of 2008/09.

10. Prime Brokerage (Sales & Trading) • Investment banks execute trades and trade strategies for some of the largest clients in the world. These include: Governments, corporations, institutional investors, hedge funds, and high net-worth individuals. • The ‘Sales’ department are tasked with bringing in business by calling clients and potential clients with trade ideas and updates on the market. • Traders are responsible for placing trades as directed by sales, or clients directly, and also for creating trading strategies of their own. • Proprietary trading is a form of trading that uses a bank’s own capital, it has been banned in the US as it risks the stability of banks which presents a systemic risk to the financial economy as a whole. It is still legal in the UK (for now), but is no longer as prevalent.

11. Asset Management • Explored further in ‘Introduction to Investment Management’ presentation. • Near $60 trillion (£40 trillion) industry. Involves the management of investments in a range of securities and products (portfolio management). • Requires research, dealing, settlement, and fund management all of which can be facilitated within investment banks – although a substantial amount of the industry is conducted by small-medium sized firms.

12. Regulation The Financial Conduct Authority (FCA), previously the FSA, regulate financial activity in the UK: ‘We supervise firms differently depending on their size and the nature of their business. This includes: • continuous conduct assessment for large firms and regular assessment for smaller firms; • monitoring products and other issues to ensure firms play fair and don’t compromise consumer interests; • responding quickly and decisively to events or problems that threaten the integrity of the industry; • ensuring firms compensate consumers when necessary’. Source: http://www.fca.org.uk/about/what/regulating

13. Litigation Recently, as part of the Dodd-Frank act 2010, the Volcker Rule separates investment banking services from commercial banking – in order to stabilise financial institutions, and remove savers funds from higher risk activities. Also, the Basel requirements (Basel III being most recent) ensure that banks bolster their balance sheets with enough capital assets so that they are able to liquidate cash quickly in financial crisis-type situations. This will reduce the risk of banks causing systemic risk in the wider economy, and protect taxpayer’s money from having to bail out banks.

14. Careers • The investment banking industry offers some of the most interesting, demanding, and well-paid jobs in the financial services sector. It is also arguably the most competitive industry in the world, and one of the hardest to break into as a student and a graduate. • Only approximately 2% of applicants to summer internships at the top investment banks are successful, so it is important to know how to set yourself apart – especially as a non-ivy league student. • UHTIS are here to help so please organise a time to meet and discuss your own strategy to strengthening your applications – it is never too early or too late to do something extra.

15. Part II – Management Consultancy • Management Consulting involves helping the leaders of businesses and organisations to improve their performance using analysis of their position, environment, opportunities and limitations. • Consultants usually possess a specialisation within a certain industry or type of activity that offers insight to executives that will be crucial in shaping a successful corporate strategy. • Ultimately, consultants provide much needed advice when managers face difficult strategic business decisions.

16. Management Consultancy Top Firms • These are the top 10 consultancy firms operating in the UK as measured by fee income in 2012/13 • The ‘Big Four’ dominate the industry with grouped income totalling approximately £8.35 billion. • The industry employs around 80,000 consultants with senior consultants (3-5 years in industry) earning over £60,000 annually on average. Source: www.AccountancyAge.com

17. Competitive Strategy Management consultants will use a range of techniques to analyse a business, its industry, the level of competition, its strengths and weaknesses, and the opportunities and challenges it faces to provide advice on how to maximise value. Competitive Strategy is one such analytical technique: “Every firm competing in an industry has a competitive strategy, whether explicit or implicit… Increased attention to formal strategic planning has highlighted questions that have long been of concern to managers: What is driving competition in my industry? What actions are competitors likely to take, and what is the best way to respond? How will my industry evolve? How can the firm be best positioned to compete in the long-run?” - Michael E. Porter (1980) ‘Competitive Strategy: Techniques for Analysing Industries and Competitors’

18. Porter’s Five Forces These are the five forces that shape competitive strategy within businesses. They allow us to understand the fundamental nature of an industry that influences how we choose to act and react in order to maximise profitability. They are widely used when considering options for important business decisions.

19. Porter’s Five ForcesCase Study: Airlines Why does the airline industry suffer from low profitability? Rivalry: intense rivalry within the industry – price competition is fierce and causes airlines to sacrifice profit just to operate. Low Barriers to Entry: new competition enters the airline market regularly as aeroplanes and airport gates can be easily rented/leased for companies who wish to start operating even small networks of flights. Buyers: the customer is extremely price sensitive and will almost always choose the cheapest airline.

20. Porter’s Five ForcesCase Study: Airlines Why does the airline industry suffer from low profitability? 4. Suppliers: aircraft & engine manufacturers (Airbus, Boeing, Rolls Royce & GE etc..) can draw out large amounts of the profitability airlines would receive as they are providing a product that requires large investment and a highly-skilled work force that airlines cannot set up easily. 5. Substitutes: in many cases, a customer could switch to travelling by car, train, or ship as an alternative to flying which pressures the airline business to try to compete for business against those other options.

21. Process for Formulating a Competitive Strategy A. What is the Business Doing Now? • Identification • What is the implicit or explicit current strategy? • 2. Implied Assumptions • What assumptions about the company’s relative position, strengths and weaknesses, competitors, and industry trends must be made for the current strategy to make sense?

22. Process for Formulating a Competitive Strategy B. What is Happening in the Environment? • Industry Analysis • What are the key factors for competitive success and the important industry opportunities and threats? • Competitor Analysis • What are the capabilities and limitations of existing and potential competitors, and their probable future moves? • Societal Analysis • What important governmental, social, and political factors will present opportunities or threats? • Strengths and Weaknesses • Given an analysis of industry and competitors, what are the company’s strengths and weaknesses relative to present and future competitors?

23. Process for Formulating a Competitive Strategy C. What Should the Business be Doing? • Tests of Assumptions and Strategy • How do the assumptions embodied in the current strategy compare with the analysis conducted in section B? • Strategic Alternatives • What are the feasible strategic alternatives that arise from the analysis? • Strategic Choice • Which alternative best relates to the company’s situation to external opportunities and threats? • Structural analysis can be used to identify the key factors driving competition in an industry and thus the places where strategic action to influence the balance will yield the greatest payoff.

24. Examples of Competitive Strategies 1. Overall Cost Leadership • Cost leadership requires aggressive construction of efficient-scale facilities, vigorous pursuit of cost reductions from experience, tight cost and overhead control, avoidance of marginal customer accounts, and cost minimisation in areas like R&D, service, sales force, advertising & so on. • A low-cost strategy protects the firm from the threat of new entrants (scale economies), gives the firm a competitive advantage (rivals will destroy their margins adapting), it defends the firm from buyer power as they seek to lower cost anyway, and it defends against supplier pressure as it provides more flexibility to cope with input cost increases.

25. Examples of Competitive Strategies 2. Differentiation • The second strategy involves differentiating the product or service provided by the firm, creating something that is perceived throughout the industry as being unique. • Differentiation, if achieved, is a viable strategy for earning above-average returns in an industry because it creates a defensible position for coping with the five competitive forces. • Unlike cost leadership, it may be easier to achieve differentiation prior to gaining high market share as the feeling of exclusivity can support this strategy. • However, in some businesses, differentiation is not compatible with low-cost products and services as it may require high spending in research or on advertising to create brand loyalty.

26. Examples of Competitive Strategies 3. Focus • Focusing on a particular buyer group, segment of the product line, or geographic market. • Unlike the previous two strategies which aim to compete industry-wide, the focus strategy is built around serving a particular target very well. • This strategy rests on creating a product or service that serves a particular target more effectively than competitors who are competing more broadly. • The firm achieving focus may also potentially earn above-average returns for its industry. Its focus means that the firm either has a low cost position with its strategic target, high differentiation, or both.

27. Examples of Competitive Strategies Failure to Select a Single Competitive Strategy A firm that attempts to achieve all three generic strategies may become ‘stuck in the middle’ and experience far lower returns than other business operating in the industry as potential customers align themselves with the businesses that clearly serve their needs & wants. Return on investment Market Share

28. Risks of Competitive Strategies Overall Cost Leadership • Technological change that nullifies past investment; • Low-cost learning by new entrants or imitators; • Inability to see required product or marketing change because of attention placed on cost lowering strategies. • Inflation in costs that narrow the firm’s ability to maintain price differential against competitors. Differentiation • Buyers make sacrifice some of the features, services, or image possessed by the differentiated firm in favour of cost savings. • Buyers’ need for the differentiation may fall, as can happen with buyer sophistication – causing the firm to fall out of favour. • Imitation narrows perceived differentiation, a common occurrence as industries mature.

29. Risks of Competitive Strategies Focus • The cost differential between broad-range competitors and the focused firm widens to eliminate the cost advantages of serving a narrow target or to offset the differentiation achieved by focus. • The differences in desired products or services between the strategic target and the market as a whole narrows. • Competitors find submarkets within the strategic target and out focus the focuser.

30. Careers All of the Big Four consulting firms have internships, placements and graduate schemes with places on offer each year in a wide range of consulting areas. Similarly to Investment Banking, they are incredibly competitive and sought-after; but the experience you will gain is first-class.

31. Thank You Further Reading: Berk, J. DeMarzo, P. (2011) ‘Corporate Finance’. Prentice Hall. Porter, M. E. (1980) ‘ Competitive Strategy’. Free Press. Contact via email: uh_trading-investment@outlook.com Come along to other seminars in the UHTIS Seminar Series to find out more about the financial services industry: Fundamental Analysis & Valuation Wednesday 26th March N101, 18:30-21:00 Technical Analysis & Trading Forex Monday 31st March N101, 18:30-20:00 Created by Harry Radburn Investment Banking and Investment Management Coordinator University of Hertfordshire Trading & Investment Society 2013/14