(although they probably don’t complain when they do). They’re the buyer of last resort, standing on the market looking to buy and sell when there are people looking to sell and buy. They’re providing liquidity.
The type of analysis used in trading operations
Many large investors that work with investment banks aren’t very transparent about the trading they’re doing — and that’s no mistake. One of the greatest downsides of trading is that when other investors get wind of the strategy and start to copy it, the strategy doesn’t work anymore.
Imagine that an investment bank’s client figured out that stocks tend to soar on the first trading day of January. Talk about an easy way to make money. The client would simply buy stocks on December 31 and sell them on January 1, or whatever the first day of trading is. But if the secret got out, other traders would buy stocks on December 31, too, which would spoil it for everyone. Why? The stock prices would be pushed up on December 31, essentially eliminating the January 1 pop.
Due to the value of keeping trading secrets quiet, you don’t often hear what investment bankers’ clients have been doing until the strategy blows up on them. But investors can see that typically trading strategies fall into several categories, including
Cross-market arbitrage: Arbitrage is a fancy word used to describe a situation when assets are temporarily mispriced relative to each other. These cross-market arbitrage strategies can get pretty complicated, because computers are programmed to find unexplained relative differences in price between stocks, bonds, exchange rates, and currency prices. The computers can locate mispriced assets and theoretically make risk-free trades.
Event arbitrage: Some trading operations try to anticipate and place bets ahead of major market-moving events. Events that may move stocks include a company being included in the popular Standard & Poor’s 500 stock market index, which is usually a boon for the stock. Another example may be a company being ripe to be bought or a small biotech firm getting approval to market a new blockbuster drug.
High-frequency technical trading: Another area of trading that some investment firms are turning to is a type of high-frequency trading where they take advantage of different trading speeds. It’s becoming increasingly common for large trading operations to develop light-speed networks that will let them place that buy or sell order just a millisecond or less before competitors, giving them an edge.
Chapter 3
How Investment Bankers Sell Companies
IN THIS CHAPTER
Investment banking isn’t exactly a glamorous business. When was the last time you heard a 6-year-old say she wants to be an investment banker when she grows up? Much of what investment bankers do is lucrative, but it’s behind the scenes and tucked in the back rooms of the financial system.
If there’s an area where investment bankers really shine, it’s in the process of selling a company to the public for the first time in an initial public offering (IPO). The IPO is one of the few times when the general public has a chance to see and interact with investment banks and the financial products they’re selling and see the role investment bankers play in the economic machine.
We introduce the importance of the IPO in Chapter 2. In this chapter, we delve more deeply into the IPO process, taking a look at what investment banks look for when selling a company in the public markets. One of the key jobs of investment banks in bringing a company to the public markets is assisting in creating a document that spells out the details of an offering, called the prospectus. Here, we explore the prospectus in detail, along with the ways investment bankers can make sure an IPO goes off smoothly.
Closely linked to the IPO process is the sell-side analysis function of many investment banks. These operations help complete the process of selling the company that investment banks are often tasked with.
Also in this chapter, you get an understanding of the types of research that go into a research report. We dissect and analyze a sample report to illustrate how investment banks dig into a company’s financials and prospects so they can either recommend a security or advise against it.
Getting Companies Ready for Sale on Public Markets
There comes a time in a company’s life when going public is often the best option. When a company gets big enough, and a broad enough audience of investors is lined up to buy a piece of a company, it’s time to strongly consider an IPO.
When a company goes public, it carves itself into pieces that investors in the general public can buy. Just about every stock you can invest in, at one point, first sold its stock in an IPO.
Companies often turn to IPOs when
Bank loans are too expensive. When a company gets bigger, borrowing from the bank becomes a relatively costly form of raising money.
Venture capitalists are too onerous. Venture-capital firms are great sources for young companies that don’t have many options. But these investors insist on big ownership stakes, stripping the entrepreneur’s ownership in the companies. Venture-capital funds are pools of money from private investors who are looking to hit it big.
Venture capitalists or other private investors want to cash out. Venture capitalists often buy companies with the idea that they’ll sell them once they get big enough to attract public investors. The IPO is a way for venture capitalists to cash in on their investment, so they can put that money into another small company. Private investors, such as private-equity firms, also urge companies to sell shares to the public so they can cash in.
Bonds are too expensive. Young companies can sell bonds to raise money. But bond investors are a nervous lot, and they tend to demand high rates of return on companies that don’t have a long-term, proven track record. Borrowing this way, especially for relatively unproven companies, can often be prohibitively expensive. Also, bonds must be repaid with interest. A young company may be reluctant to sign up for a deal that requires it to make routine interest payments when its cash flow may be uncertain.
After companies exhaust their normal avenues for raising money, that’s when IPOs come into play. IPOs are a way for companies to get investment capital from investors, who want to be owners. These owners are happy to get