Chapter 5 - Equities Flashcards

Question

Share Buybacks

Answer 1

- shares bought back can be cancelled or held in treasury (sometimes used later on to fulfil share options) - shares either bought in open market or make a tender offer - reduces no. of shares in issue, increases dividend per share - boosts NAV per share and causes price to rise as fewer shares in market - can be viewed negatively as suggests nothing worthwile that management can do to reinvest cash in business - way to return surplus cash to shareholders without having to increase dividend, as it would then be difficult to reduce dividend in future as this would be a sign of poor company performance

Answer 2

- Equity investments not listed on an exchange - No regulated market - Investors can often influence direction of company - Seen as an alternative asset class so has become popular for diversification reasons - Partners (investors) align interests of the managers via performance incentives such as access to additional financing - Size of PE market has increased substantially due to: 1) Potential for higher returns 2) Development of the limited partnership as an intermediary (reduces information asymmetry) 3) Regulation changes, permitted more PE investment by pension funds - Returns generally higher than many other asset classes due to higher risk and lower liquidity and highest for Venture Capital, lowest for Mezzanine - PE firms have annualised return of 12.29% over last 10 years

Answer 3

- Investments in limited partnerships considered illiquid so investors expect premium for this - Risk of losing entire investment - Venture Capital considered most risky, Mezzanine least risky - Secondary market does exist, however transactions are complex and infrequent, limiting ability to exit investment before the fund matures - Investments are long term, often taking years to realise returns - PE investments can carry high degree of indiosyncratic risk - Capital is committed over a multi year period, and further capital can be called - Information Asymmetry can exist which can result in: 1) Adverse Selection - owners and managers know far more about the company than investors, especially as firm is required to make very few public discolsures. Weaknesses are often overlooked by management and strengths emphasised 2) Moral Hazard - after receiving finance, managers may change the way they run the business for their benefit

Answer 4

- Start ups looking to raise funds or later stage company's looking for rapid growth or an exit for investors - Often used when all other lending avenues exhausted, or company is too small to access bank lending lines - Investors are normally partnerships

Answer 5

- Companies with high debt/leverage, which likely means their debt or shares pay a high yield - To improve the statement of financial position, the comany may decide to offer new bonds to a new group of buyers - Investors look to influence negotiations over the restructuring of the debt and the strategic direction of the firm, often with sale of non-core business assets

Answer 6

- Growth of PE sector is closely connected to rise of LBOs - Companies are acquired using borrowed funds, with the assets of the aquired company used as collateral - Syndicate of banks, hedge funds and PE groups lend money to an LBO vehicle - Vehicle then seeks to buy controlling interest in a company using high amount of borrowed capital - Syndicate receives LBO bonds which often pay high yields

Answer 7

- Often more expensive way of financing for a company, as it does not qualify as is unsubordinated and therefore investors demand a high yield - Ranks just ahead of ordinary shares if company defaults

Answer 8

- most investors access PE through funds who become limited partners - Underlying investments in a PE Fund include: - Venture Capital, private medium firms seeking expansion, public firms seeking finance for an LBO, firms in financial distress, public financing of infastructure buyouts - Many PE funds require substantial initial investment plus additional investment in first few years - Buyout funds are largest area: 1. Large cap - sell non-performing business asset or want to divest a spin-off business. Purchase a firm, then de-list with a view to increase profitability and then relist via a SIPO 2. Inter Cap - not listed in the first place, so buy with view to improving performance and then list 3. Divi Cap - issue debt to finance a special divi to general and limited partners - Gains are realised through listing, sale of company or dividend capitalisation - Capital often locked for long periods and requires substantial initial investment but potential for higher returns - Most PE funds only offered to HNWIs or sophisticated/institutional investors

Answer 9

- Partnerships have a fixed life of around ten years, for first three, general partners will invest the capital and after will liquidate the investments to distribute to investors - Limited Partnerships play valuable role in mitigating risks in the PE market: 1) General Partners - invest and run the assets as have industry or entrepreneurial experiance - unlimited liability - limited number - put up small amount of capital (usually 1%) 2) Limited Partners - limited liability - unlimited number - provide bulk of capital - often institutions

Answer 10

- Involves a plc buying out the shareholders in order to become partly or entirely private - Recent example is purchase of HL by private equity consortium led by CVC Capital Partners, Nordic Capital and Abu Dhabi Investment Authority which led to HL being delisted from the LSE - Reasons for PE buyouts include: 1) Management buyouts (firms with strong cash flow) 2) LBOs (firms with strong cash flow) 3) Financial Distress (turnaround situations) 4) Desire to avoid company registration costs 5) Raise funds when industry is out of favour with public investors

Answer 11

- Deal and price paid by an investor is negotiated directly with the management of the PE firm - PE investments are less visable to the general public, with no transparent prices quoted - PE firms have no consistent valuations, they often appear robust during market sell-offs - Investors in PE firms become limited partners, so can request info on internal investment plans and policies - PE investors are active in investment activity

Answer 12

- When selecting a company to invest into, they are screened for basic criteria such as type of investment, industry area, location and whether its within the partners area of expertise - Extensive due diligence for a final selection will include: 1) Visits to the company 2) Discussions with employers, suppliers and customers 3) Using lawyers and accountants to examine the company 4) For startups - examining management quality 5) Established firms - understanding the business 6) Distressed companies - meeting with lenders 7) LBOs - cashflow forecasts and ability to repay debt

Answer 13

- Performance incentives align the interest of managers and partners - Direct control mechanisms include: 1) Board Representation - GPs on the board may have skills to run the company and necessary resources 2) Voting Rights - partnerships stake may be large enough to give them control or significant influence or if doesn't own over 50%, may have special voting rights 3) Access to Additional Finance - partnership may not give the company all the required funds at the start, and may hold some back

Chapter 5 - Equities Flashcards

(37 cards)