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Class Notes for CH 16: Securities Firms and Investment BanksOutline-Overview-“Securities Firm and Investment Bank Activity Areas”-“Size, Structure, and Composition of the Industry”-Initial Public OfferingsLearning GoalsLG 16-1 Know the different types of securities firms and investment banksLG 16-2 Understand the major activity areas in which securities firms and investment banks engageOverviewExamples of firmsGoldman Sachs, Morgan Stanley, Merrill Lynch2. What do they do?Investment banks: raise debt and equity securities primary market(originate, underwrite, and place securities)Give adviceEx: merger restructuringSecurities Firms: trade securities secondary market(brokerage services or market making)A key difference between securities firms/investment banks and most other types of financial institutions: they do not transform securities, rather they serve as brokers/middlemenCommercial bank: deposits loansMutual funds: cash/investment shares of fundNote: the industry structure has changed dramatically over timemany major investment banks operate as part of a larger entityMerrill Lynch Bank of America“Wall Street” long hours/high pay (1 protected weekend per month)Most diverse group of firms“Securities Firm and Investment Bank Activity Areas”LG 16-2 Understand the major activity areas in which securities firms and investment banks engageFirm\’s Life CycleIdea washer puts clothes in dryerRaise money Family/friends/savingsEight Key Activities:1. Venture Capital: professionally managed pool of money used to finance new and often high-risk firmsCommercial banks may be reluctant to finance new firmsAngel venture capitalist: wealthy individuals who invest early in firms“spray and pray” give each firm $25kShark TankLook for: high returns & easy exit (IPO; sell firm in a merger)Pitch SmackdownApp- multiplayer gameProtein “candies”Break-up-box2. Investment Banking: underwriting and distributing new issues of debt and equity securities“Traditional”IPOs, bond issues, etc.3. Mergers and Acquisitions: advise and assist on mergers and acquisitionsIdentify targets, negotiate, underwrite securities offered in the transaction, assess value of target, help in resisting takeovers**which firm dominates which market (from table) exam question**4-6: Secondary Market Activities4. Market Making: creating a secondary market for a securityEquity securities, bonds, derivatives (options, futures, mortgage backed securities, etc.)Make money on spreadBonds- buy for $764, sell for $765 spread $1Don’t really care which way the price goes, goal is to have a liquid market5. Trading: take an active net position in an assetPosition trading- taking a position for weeks or months waiting for a price changeRisk arbitrage- attempting to profit from some information release (Ex- Fed announcements) Stock brokerage- executing trades for clientsMake money on the rise in price of the asset OR a commission chargedEx: E Trade $9.99 stock trade6. Investing: managing pools of assets such as mutual fundsMake money based on assets under management (AUM)Ex: 50 basis points$10M x 50 basis points = $50,0007. Cash Management: bank deposit-like cash management accounts, allow clients to write checks against a money market mutual fund account8. Other Service Functions: escrow services, research and advisory servicesEscrowResearchAdvisory“Size, Structure, and Composition of the Industry”LG 16-1 Know the different types of securities firms and investment banksFive large investment banks at beginning of 2008 and ultimate fate1. Lehman Brothers bankrupt2. Bear Stearns acquired by JP Morgan3. Merrill Lynch acquired by Bank of America4. Goldman Sachs converted to commercial bank holding company5. Morgan Stanley converted to commercial bank holding comapny**No large, independent investment banksNational full-service investment banks1. Commercial banks or financial services holding companiesExtensive domestic and international operations. Offer advice, underwriting, brokerage, trading, and asset management services.Includes: Bank of America, JP Morgan Chase, Morgan Stanley2. Specialized firmsMore active in corporate finance or primary market activities, less active in trading and secondary market activitiesIncludes: Goldman Sachs- IPOs, Mergers3. Large investment banksConcentrate in major cities, focus on institutional client basesIncludes: Lazard, Greenhill & Co.Rest of Industry1. Regional Securities Firms. Includes: Raymond James Financial2. Specialized Discount Brokers. Includes: Charles Schwab(effect trades without offering advice)3. Specialized electronic trading securities firms. Includes: E*Trade(allow trades without the use of a broker through a computer network)4. Venture Capital/Private Equity. Includes: Sequoia Capital, Bain Capital 5. Other specialized firms. Includes: Capitalink, Duff & Phelps (research boutiques, floor specialists)Initial Public OfferingsMotivation major transition Private publicSales? Profits? Cashflow?CEO salary?Owners?Chance for early investors (VCs) to exitFacebook IPO in May 2012Basic Process (for any IPO): Hire investment bankerSet initial price range and shares to be issuedFile prospectus with SECOrganize a roadshowBuild a book of indications of interestDecide on final offer price and shares to be issuedShares trade*roadshow give investors informationget information from investorshow interested?Reasonable price?Concerns?Resolve information assemetryFacebook initially wanted to sell 337M shares for $28-$35 per share. This included 180M new shares and 157M secondary sharesCash raised: $9.4 billion- $11.8 billion337 180 of which are new shares; 157 of which are: secondary shres held by employees, founders, early investors (exit)421 180 of which are new shares; 241 of which are secondary sharesFinal offering 421 million shares, $38 per shareIn mid-May, FB changed this to 421M shares for $34-$38 per shareThis includes 180M new shares and 241M secondary sharesFinal offering $421M for $38 per share412 x $38 = $16 billion cash raisedcash to firm: 180 x 38 = $6.8cash to investors: 241 x 38 = $9.2 billionFees: 7% $16 billion * 7% = $1.12 billion fees to Morgan StanleyInside Facebook's IPO: From Darling to Disaster – Decoder (7 minutes), by Reuters PlusHighlights:Early 2012, Facebook announces plans for IPOMorgan Stanley chosen as investment bankerFacebook chooses to list on NASDAQPurchase of InstagramFacebook warns that growth in mobile usage is hurting businessQuarterly revenue declineMay 9: Price range $28-$35 per shareMorgan Stanley analyst cuts revenue forecastMay 15: Raise price range $34-$38 per shareGM stops advertising on FacebookMay 16: Increase number of secondary shares to be soldIncreases number of shares that were soldMay 17: Final share price $38 determinedMay 18: Shares trade (after some technology glitches) on NASDAQMorgan Stanley had to support the offer (this is part of the risk born by inv. banker)Price closes at $38.23Key Issues in IPOsRoad shows-give & get informationBookbuilding-gather indications of interest help price offeringFirst Day Returns / Money Left on the TableFacebook (unusual): offer price: $38Closing price: $38.23, return .6%Groupon (more common): offer price: $20Closing price: $26.11, return 30% ................
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