The Bull's Pen

Overview : Upside risks to inflation and downside risks to growth Despite signaled rate cuts, interest rates are likely to stay elevated as: Still tight monetary policy Higher borrowing needs by US Treasury (and lower foreign demand for US Treasury bonds) Inflation still above Fed’s 2% target Factors unrelated to Fed policy may slow consumer spending Households have less excess savings compared to COVID levels Student loan payments restarting Outlook for corporate performance Outlook for lending Outlook for inflation Many are optimistic about the economy due to possible rate cuts in 2024. However, despite resilient strength in the economy, there is still more downside risk than potential upside surprise. While soft landing is not impossible, it is likely that interest rates will continue to be elevated and for longer than the market expects.  Key Trends and Analysis: Despite signaled rate cuts, interest rates are likely to stay elevated Even if rate cuts were to persist, they’re not go

Make sure to read the most important part at the bottom - "M&A Financing" Types of Mergers: Horizontal Integration: mergers of companies in the same industry Vertical Integration: same production vertical but different level, e.g. tech company acquiring chips manufacturer; restaurant buying delivery service Conglomerates: acquiring completely unrelated businesses in different industries or geographies for diversification Why would you buy a company? Consolidation - making a bunch of smaller companies into one Cost savings - such as from strengthened supply chain etc Geographic expansion Seller is undervalued Acquire new customer base or distribution channels Tax benefits Expand or diversify product lines Intellectual Property CEO ego and pride Why would you want to get acquired? PE Firms or Private Businesses: PE firms and owners of private businesses may want to cash in their hard work after owning or operating their business for a period of time The alternative - IPO -

When calculating recoveries in a liquidation: EV of company exceed the face value of debt: senior creditors paid first If most senior class of creditors is unimpaired, junior creditors will be paid If most senior class of creditors is impaired, junior creditors will not receive anything DEF Pari Passu: both securities are on an equal footing in the capital structure (same seniority) HoldCo/OpCo Structure: HoldCo: company that holds equity in operating companies OpCo: operating subsidiaries where the assets themselves typically reside Reasons for HoldCo/OpCo Structure: For large companies that sell products around the world, it can be efficient to have country-specific operating subsidiaries for regulatory, tax, and accounting purposes By having a HoldCo, we have another area to raise debt. Debt issued at HoldCo tends to be the yielding debt as it's removed from where assets reside Structural subordination: debt at OpCo level is closer to assets of the company and will be made whole

Recap : In the last post, we covered capital structures and some basic terminology Absolute Priority Principle: in a distressed/bankrupt situation, a company's capital structure determines the order of claims on a company's assets. This order is:  Secured Debt Unsecured Debt Subordinated Debt Mezzanine Debt Equity Bonds vs. Loans: Bonds: source of funding that can be obtained from the public and usually have a par value of $1000 Loans: obtained through bank, more restrictive covenants and not as liquid as bonds Types of secured (senior) debt: Revolver: Secured, 1st lien Corporate credit card Floating interest (LIBOR+spread) Term Loan A: Secured, 1st lien 5 Year Term Amortizing - payment schedule over time Term Loan B: May be 2nd or 1st lien 5-8 Year Term No amortization - bullet maturity (lump sum in the end) Types of unsecured (junior) debt: Mezzanine: Mix of debt and equity, e.g. convertible debt, convertible preferred stock PiK interest Reasons for Financial Distress: Bad ma

Background: For most bankruptcies, you won't even know it's happening as it's happening In a sophisticated financial system, bankruptcy should not equal the end of the business because c ompanies are generally worth more alive than dead. Instead, business is transferred from equity shareholders to the lenders Restructuring: process where a new capital structure is determined Restructuring Investment Bankers work with distressed companies and/or stakeholders to help them with M&A, financing, and restructuring negotiations Basic Problem of Restructuring: Basic Problem: a firm's financial value (assets value) is less than its debt component Basic Question: what is the firm worth?  In a bankruptcy scenario, equity is worth however much we think it's worth Some distressed companies could be worth a lot but are just facing temporary debt issues There are 2 sides in restructuring and distressed situations: Debtors: companies, borrowers of debt Creditors: different grou

Intro: TLDR: private credit is any loan that isn't a bond (not publicly traded) and not issued by a bank The non-investment grade credit markets in the US and Europe have expanded threefold in size since the Global Financial Crisis (GFC), growing from $1.7 trillion to $5.1 trillion. Companies in need of debt financing can either turn to banks for a loan—which would then either hold the loan on its balance sheet or syndicate it to a group of similar investors—or they can turn to private credit.  Private Credit: loans provided by lenders other than banks. Private credit funds lend directly to companies, often without using investment banks as an intermediary. They hold the debt and collect interest, rather than sell it off in pieces to other investors like a bank would. While a PE firm buys all or some of a company, private credit firms lend money to a company directly. AKA: In private equity, you are the owner of the business, and when it comes to private credit, you should operate

Introduction: During the 2008 financial crisis and the initial stages of COVID-19 in 2020, the Federal Reserve aided investors by lowering interest rates, making it easier for asset prices to rise during an economic downturn. Consequently, PE investors and strategic buyers found lucrative opportunities—the prevailing circumstances allowed them to acquire high-value companies at significantly reduced prices, enabling the acquisition of quality investments at bargain rates.  But the current situation has taken a different turn, with the Federal Reserve adopting measures that work counter to the interests of investors. By raising interest rates, the Fed is creating obstacles for asset prices to go back up. As a result, the PE market is seeing many changes in trends and policies, with many firms shifting to emphasize their credit arms. So what exactly is happening? How do rising interest rates affect private equity? Let's find out.

Basic LBO Walkthrough: Make transaction assumptions on the purchase price Make a Sources and Uses table  Project out a company's financial statements to free cash flows after debt paydown Make assumptions about the exit and calculate the returns (MoM and IRR) Purchase Price Assumptions: Public company: the purchase price is mostly based on a premium to its current share price Calculate its purchase equity value and then adjust for cash and debt to reach purchase enterprise value Private company: assume entry EV/EBITDA multiple to reach purchase enterprise value directly Sources and Uses of Funds: Sources: All forms of debt: revolver, term loans, senior notes, subordinated notes, mezzanine, preferred stock, and other debt products Management Rollover Excess cash Sponsor Equity Uses: Equity purchase price of the company Advisory, legal, and financing fees Refinanced debt: if the debt is refinanced, the PE firm repays it using new debt and equity After creating a Sources and Uses tabl

 Private Equity: Funds and investors that directly invest in private companies or that engage in buyouts of public companies, resulting in the delisting of public equity VC and growth equity are under the PE umbrella LBO Overview: Acquisition where a significant part of the purchase price is funded with debt. The remaining portion is funded with equity from financial sponsors (PE firms) After the acquisition, the company will be fully controlled by the PE firm and will have a leveraged capital structure Companies acquired by PE can be either private or public Key difference between a PE firm's acquisition and a normal company's acquisition: PE never plans to hold a company forever Timeline of an LBO: PE firm searches for undervalued companies that could yield high returns if managed properly PE firm uses cash (equity) and leverage (debt) to buy the company PE firm will run the company for several years and make improvements After a period of 3-5 years, the PE firm will sell the

Read the previous post on Diluted Shares Outstanding Accretion/Dilution analysis refers to analyzing whether an M&A deal actually adds value to the buyer. In accretion/dilution analysis, P/E and EPS are the most important metrics Accretive deal Represents a deal where the profits of the acquisition outweigh the costs Dilutive deal Represents a deal where the costs of the acquisition outweigh the profits There are 2 approaches to conducting accretion/dilution analysis in interview questions: Comparing the cost of capital with the seller's yield Comparing the pre-acquisition EPS with pro forma EPS Some formulas to keep in mind: PE = Share Price / EPS PE = Equity Value / Net Income EPS = Net Income / No. Shares Outstanding 1. Costs of Capital Approach: Cost of Cash = Foregone Interest Rate on Cash * (1 - Buyer's Tax Rate) Cost of Debt = Interest Rate on New Debt * (1 - Buyer's Tax Rate) Cost of Equity = Reciprocal of the Buyer's PE Multiple (Net Income / Equity Value)

Diluted shares outstanding vs. Fully diluted shares Shares outstanding: actual number of shares of common stock that have been issued as of the current date Fully diluted shares: number of shares that would be outstanding if all "in the money" options were exercised Diluted shares = basic shares + dilutive securities Dilutive securities include options, restricted stock, and other securities that can become common stock Types of dilutive securities: Stock options: issued to pay and motivate employees; gives employees the option to purchase common stock at a given price over an extended period of time Check for in the money / out the money Restricted Stock (RSU): another form of stock-based compensation. Employees get shares subject to vesting. Unlike options, there is no exercise price, and employees receive the stock free and clear upon vesting Don't have to check for in the money / out the money Convertible bonds: can be converted into common shares upon a certain strik