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Investment Banks

Investment banking is a specialized segment of banking that helps corporations, public sector organisations, governments and other large institutions raise capital (money) and execute complex financial transactions. Unlike commercial banks (which take deposits and lend to individuals & corporates), investment banks focus on capital markets, mergers & acquisitions (M&A), and advisory services.

Investment Banks advise corporations and institutions of all sizes on mergers and acquisitions (M&A), meeting the most complex strategic needs in local markets as well as on a global scale. Collaborating across geographies, industries and products, they provide comprehensive and innovative financing, advisory and risk solutions to clients. Clients benefit from bespoke solutions combining: 

  • In-depth knowledge of sector and market dynamics, with M&A bankers based locally in every major market.
  • Innovative advice on valuation, transaction structure, deal tactics and negotiations.
  • Rigorous execution delivered with responsive and agile service.
  • Comprehensive financing through debt and equity issuance platforms. 

Core Functions of Investment Banking

1. Mergers and Acquisitions and Divestitures

IBs act as a financial advisor to identify and facilitate strategic merger and acquisition, sale of business or alliance opportunities, global joint ventures, inbound public takeovers, or cross-border deals. Breakdown of activities given below:

  • Advise potential buyers on which companies to target
  • Help sellers screen potential buyers
  • Suggestions about what price to offer/accept
  • Negotiation support
  • Structuring the deal, whether to pay in cash vs. pay in stock or hybrid.
  • Mergers and acquisitions
  • M&A valuation
  • Determinants of market shares
  • Who gains from mergers?
  • Financing: cash vs. stock

2. Debt Underwriting

The Debt Capital Markets team helps clients execute local and foreign-currency debt transactions with specialized teams servicing financial institutions, corporates, public sector agencies and sovereigns.

I. IBs help companies and governments raise money by issuing corporate and government bonds and advises on following areas:

  • Pricing of bonds
  • Yield curve
  • Corporate vs. government bonds
  • Callable bonds, convertible bonds
  • Underwriting services

II. Underwriting: IBs act as intermediate between the issuer and investors (HNI, Banks, Mutual Funds, Hedge Funds, Sovereign Funds, Insurance Companies, Governments)

  • Act as primary dealers for the government
  • Have a certification role for companies that want to issue bonds
  • Proprietary trading: Trading with the bank own money

3. Equity Underwriting

In Equity Capital Markets, IBs originate and execute equity and equity-linked transactions, including IPOs, rights issues, accelerated bookbuilds and convertibles. Breakdown of activities given below:

  • Evaluate the issuer
  • Determine the offering price
  • Buy the shares from the issuer
  • Find investors and sell the shares
  • Why go public?
  • The IPO process
  • Syndicates in IPOs
  • Market shares in IPOs
  • Underwriting spread in IPOs
  • Underpricing of IPOs
  • Long-run performance of IPOs
  • Follow on stock offerings
  • Underwriting services

4. Derivatives products

IBs use securitization products, structured banking, reinsurance and derivative hedging solutions for complex bank, corporate or insurance-specific asset and liability risks.

  • Futures
  • Options
  • SWAPS, CDO, CDS

5. Asset Management

Breakdown of activities given below:

  • Managing short-term cash flows of corporate clients
  • Asset management:
  • Active vs. passive management
  • Performance measurement
  • Management of long-term bonds and equity portfolios of investors
  • Institutional investors: insurance companies, pensions funds etc.
  • Private investors

6. Asset Securitization

Breakdown of activities given below:

  • Issuance of securities using a pool of similar assets as collateral
  • Mortgage-backed securities, asset-backed securities
  • Private equity: refers to shares in companies that are not publicly traded

7. Leveraged Buy Outs

IBs arrange financing for leveraged buyouts and corporate acquisitions along with on-going refinancing needs using a variety of equity and debt products. A Leveraged Buyout (LBO) is a financial transaction where a company (or one of its divisions) is acquired using a significant amount of borrowed money (debt) to meet the cost of acquisition. The assets of the target company are often used as collateral for the loans, and the cash flows of the acquired business are used to repay the debt over time.

8. Sales & Trading (Market Making)

  • Facilitating trades for institutional clients (hedge funds, pension funds).
  • Proprietary Trading .
  • Providing liquidity by acting as a market maker (buying/selling securities to maintain a market).

Investment Banking Divisions

Most large investment banks are structured into three main areas:

1. Front Office (Revenue-Generating Roles)

  • Investment Banking Division (IBD): Works on M&A, IPOs, and capital raising.
  • Sales & Trading (S&T): Executes trades for clients and the bank itself.
  • Research: Analyses stocks, bonds and industries to guide investors.

2. Middle Office (Risk & Compliance)

  • Risk Management: Monitors financial risks (credit, market, operational).
  • Compliance: Ensures adherence to financial regulations.

3. Back Office (Operational Support)

  • Settlement & Clearing: Ensures trades are processed correctly.
  • IT & Accounting: Maintains systems and financial records.

Top Investment Banks

The largest global investment banks include:

  • Goldman Sachs
  • Morgan Stanley
  • JPMorgan Chase
  • Bank of America Merrill Lynch
  • Citigroup
  • Barclays
  • Deutsche Bank
  • UBS
  • Credit Suisse (now part of UBS)

Boutique investment banks (smaller, specialized firms) include:

  • Lazard
  • Evercore
  • Moelis & Company
  • Rothschild & Co

Reasons for Mergers and Acquisition

1. Synergies & Strategic fit – Combining business activities, overall performance efficiency tends to increase and overall costs tend to drop, due to the fact that each company leverages off of the other company’s strengths.

2. Increase Supply-Chain Pricing Power– By buying out one of its suppliers or distributors, a business can eliminate an entire tier of costs. Specifically, buying out a supplier, which is known as a vertical merger which usually let a company save on the margins that the supplier previously add to its costs. By buying out a distributor, a company often gains the ability to sell their products at a lower cost.

3. Eliminate Competition – Many M&A deals allow the acquirer to eliminate future competition and gain a larger market share. On the downside, a large premium is usually required to convince the target company’s shareholders to accept the offer.

4. Growth – Mergers can give the acquiring company an opportunity to grow market share without doing significant heavy lifting. Instead, acquirers simply buy a competitor’s business, usually referred to as a horizontal merger.

5. Succession and retirement – One of the major drivers for M&A is when the owner is looking to retired and/or transfer the business to a successor or a potential buyer. With this the owners might look more for a strategic buyer who understands the business and ensures smooth transfer for the employees and related stakeholders.

Merger & Acquisition Valuation Methodology:

1. Market-Based Valuation: assessing the value of a company by comparing it with similar companies in the market. 

(a) Comparable Company Analysis (CCA): It involves identifying publicly traded companies in the same industry with similar growth prospects, and economic characteristics. Analysts use financial metrics like revenue, cash flow and multiples such as Price to Earnings (P/E), Enterprise Value to EBITDA (EV/EBITDA), EV/Sales and Price to Book (P/B) ratios and apply them to the target company’s financials to derive a valuation multiple. 

(b) Precedent Transactions Analysis: This approach examines the prices paid in past M&A deals involving similar companies to establish a benchmark valuation. This method analyzes the deal multiples paid in these transactions, adjusting for differences in size, market conditions at the time of the deals, and anticipated synergies. It is used to gauge what acquirers have historically been willing to pay for companies similar to the target, providing a basis for potential market pricing. 

2. Income-Based Valuation:

Discounted Cash Flow (DCF) Analysis: DCF valuation estimates the present value of a company based on its projected future free cash flows. The discount rate reflects the risk of the investment. Forecasts free cash flows (FCF) over 5–10 years. Determines the terminal value (beyond the forecast period). Discounts all cash flows to present value using the Weighted Average Cost of Capital (WACC). Adjusts for debt and cash to arrive at Enterprise Value (EV) and Equity Value.

3. Asset-Based Valuation: This method assesses the company’s value based on its balance sheet, adjusting for assets and liabilities at market values. 

(a) Net Asset Value (NAV):This method calculates the difference between a company’s assets and liabilities to determine its net asset value. 

(b) Liquidation Value : Liquidation Value method estimates the net cash that would be received if all assets were sold and liabilities settled. This value is typically lower than other valuation methods as it assumes assets are sold under distressed conditions.

(c) Replacement Cost Method: Replacement Cost method calculates what it would cost to replace a company’s existing assets with identical new ones at current market prices. This method provides a value based on the current cost of assets without considering depreciation.

(d) Adjusted Book Value Method : This method assesses the company’s value based on its balance sheet, adjusting for assets and liabilities at market values. This often involves revaluing assets and liabilities to reflect figures more accurately.

4. Revenue Multiple: A revenue multiple valuation is one of the most common methodology used in determining the value of a company. It provides a helpful metric when comparing companies with differing profit levels but similar margins, products, markets and competition. Used by IT and Start-Ups. 

5. Leveraged Buyout (LBO) Analysis: This method evaluates the potential for a leveraged buyout (where a significant portion of the purchase price is financed with debt). LBO is a popular financial strategy in mergers and acquisitions (M&A) where a company is acquired primarily with the use of debt to finance the purchase.

6. Sum-of-the-Parts (SOTP) Valuation : Breaks a company into individual business units and values each separately. Suitable for Conglomerates with diverse operations or Spin-offs or divestitures.

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