Amongst the Stars (Deprecated)

The End

2011-04-25T16:57:00.000-04:00

The irony is that it isn’t really the end but the beginning. As great as the MBA is, we all enter it as a gateway to better things afterwards, trying to look two years ahead. So it is with that expectation that we enter the program. But there is so much that happens in between, so many things that for one reason on another don’t make it on the blog and are therefore not captured. It has always been my aim that this blog would serve not only as a pensive collection for reflection, but also act as a source of entertainment, ideas and discussion with its readers. It is my hope that the impression I leave here is an honest and comprehensive reflection and an imprint of myself and my experiences contained within its digital pages.

I am grateful for all the rich experiences while I’ve been on the program. Obviously, I’m very lucky, having the opportunity to reap the benefits of the program by meeting smart hardworking people, being exposed to brilliant ideas and new ways of thinking, and taking full advantage of all the programs available whether they are international programs, case competitions or classes. I certainly feel like I'm on the top of the world right now seeing nothing but clear horizons.

I have throughly enjoyed my time on exchange in London and studying in Toronto. It’s with an invigorating sense of optimism that I look forward to the future. The adventure is hardly over as I’ll spend the summer travelling. And as always, even then, the end of that period is simply the beginning of the next intrepid endeavor.

Service Management Field Trip – Thessaloniki

2011-04-21T03:02:00.001-04:00

Yesterday marked the last day of in person contact with our project sponsors. They have sent us some preliminary information to analyze and signed off on the project scope and definition. All that remains now is for us to do our analysis and provide our report. That coupled with the completion of our individual assignments will tie up the end of this course.

Shown above: View of Aristotelous Square from the Orizontes rooftop restaurant in Electra Palace Hotel Thessaloniki.

This has been a unique experience, to hear from the mouths of people who live here their opinion on a very timely topic: globalization, competitiveness and the structure of a nation’s (Greece’s) economy. Our professors did a lecture on Monday talking about the characteristics of the Greek economy, breaking down GDP components and telling a story about Greece’s economic focus and structure over the past 5 years as a backdrop for the current conditions the country is facing. They also prescribed a logical recipe for what would be needed to turn the Greek economy around and the challenges involved. These sentiments were echoed by many of the project sponsors who participated as many of them were looking to boost their competitiveness and engage the other economies of the world.

Today, I’ll be spending most of my time wrapping up all remaining loose academic ends in the hope of leaving nothing unfinished for my return to Toronto.

Prince William and Kate – Let the Market Decide

2011-04-17T04:43:00.001-04:00

Apparently, Brits will bet on anything. I was just watching the BBC and there was a short clip on questions Brits were asking and what bookies were placing in terms of odds of various events happening at the wedding: Kate’s car breaking down, Prince Harry dropping the ring etc.

This got me to thinking about mathematically predicting the future. Not just in physical models (for instance forecasting weather) which is difficult enough, but also in these sort of abstract ideas. After all, how do you predict what is Prince Harry’s chance of dropping the ring? Let’s say you could even come up with a very convincing model that would give you one good guess.

Another method would be to let the invisible hand of the gambling market decide. Assuming you could get enough interested people to bid in the “market” on an individual question, having more or less people bid for or against any particular question can give you an indication as to whether the odds offered are too “generous” and allow you to recalibrate the odds directionally until you arrive at a relatively stable number.

For example, when asked: “What’s the chance of the Queen wearing a blue hat?” initially it’s even odds. However, people start doing their homework, statistical multi-factor regressions, etc and discover that she actually tends to wear a blue hat quite often (especially at royal weddings) and people starting overwhelmingly taking bets that she will wear a blue hat. If the bookie is paying attention, they will start moving the odds, maybe now offering 2:1 odds that she will wear a blue hat. People start fine tuning their model and continue to make bets until the odds rest at 3:1 (the current odds of the Queen wearing a blue hat). The bookie takes bets on either side taking the spread.

The invisible hand of the gambling market has determined the probability of the Queen wearing a blue hat. While we aren’t even sure what models were used, assuming intelligent people using real money have staked a “best guess” at what the appropriate value for the probability of the Queen wearing a blue hat is, we are given another robust answer.

Back in Thessaloniki

2011-04-17T04:07:00.003-04:00

After taking some time to do a whirlwind tour of the Mediterranean, I’m back in Thessaloniki to finish my last class of the Exchange as well as my MBA program: Service Management field trip. I’ve met two of my group members as well as classmates from other teams as we did some basic exploring of the city’s waterfront.

Shown above: Thessaloniki waterfront at sundown.

We have our first official class today. We've already been in contact with our sponsor company and also have our first group meeting today as well as we meet face to face for the first time.

Tomorrow, we have an arranged city tour which I am looking forward to. Also, today is Palm Sunday, which marks the beginning of Holy Week in Greece which is a very important holiday with unique celebrations that I am looking forward to.

I am also in the process of completing my final project for Managing Corporate Turnarounds as my other team members have sent me their parts and I finish up the write up for our class.

After my class is done here on April 21st, there are a few days to spend before flying back to London on the 24th. My flight back to Toronto is the 26th. While I have really enjoyed my time here, I’m looking forward to going home, visiting my sister in New Orleans on the 27th (to drive back to Toronto).

I’ll be spending May studying for the CFA II exam after which I’ll also have the opportunity to visit friends and family in Australia in June and Malaysia (with a chance to climb Mt. Kinabalu and dive in Sipadan hopefully) in July before I return to Scotia Capital in August.

Ship of Theseus as a Metaphor for Replacement Cost

2011-04-07T09:20:00.000-04:00

Looking at the Parthenon being restored, it reminds me of another Greek concept: the ship of Theseus. It is essentially an identity dilemma: If you take care of something, but are forced to replace parts due to decay over time, is that object still the same? This is something I’m sure archeologists wrestle with when they rebuild replica parts to restore murals or structures for which the original parts are long gone. Even if they use the same material, artistry and methods, the original has lost something ineffable.

This concept has been extended several times with several unique spins, my favourite being Plato’s carriage, where Socrates and Plato exchange parts on their carriages until finally “Socrates’” carriage is made entirely of Plato’s original carriage and vice versa. At what point did the identity of the carriage change?

In a vain attempt to bring all my philosophizing back into the MBA realm of finance, it’s sort of interesting when you think about it in the context of the idea in accounting principle of replacement cost or M&A. While accounting will capture the physical quantities contained within a company’s finances, there also exists value beyond the sum of its parts in the same way you would expect an M&A transaction’s synergies to broaden the qualities of the combined entities: that seemingly ineffable quality.

Parthenon and the Golden Ratio

2011-04-07T08:32:00.007-04:00

Today I visited the Parthenon which is one of my favourite buildings and the preeminent landmark of Athens and located in the Acropolis. And yet, many people are unaware of the beautiful mathematical design it holds in plain view. Built into the Parthenon’s design you will often discover that many porportions are designed to the golden ratio, also known as the divine proportion, the ratio that many Greek’s believed to be the source of proportional mathematical beauty.

Shown above: Parthenon

Many believed that this ratio occurred often in nature and was the basis for beautiful proportions (for example it appears in Leonardo Da Vinci’s Vitruvian Man as the ratio between the length of the arms and legs). Another occurance is with Fibonacci numbers as the ratio between them is an approximation of this same ratio (Fibonacci numbers are numbers in a sequence in which the next number is the sum of the previous two numbers). The approximation becomes more accurate the further out you go. Note: It's only an approximation because the first two numbers are one and one.

The golden ratio is mathematically defined as follows:

(A + B) / A = A / B

Or in layman’s terms, the proportion between two measures is the same as the proportion of their combined length and the larger length. Note that this definition can be recursive and applied over multiple lengths repeatedly.

Also note, that the proof for the actual ratio is self is quite elegant:

(A + B) / A = A / B (Multiplying both sides by A x B we get)

AB + B^2 = A^2

0 = A^2 – AB – B^2

= A^2 – AB + 1/4 B^2 – 1/4 B^2 – B^2

= (A – 1/2 B)^2 – 5/4 B^2

Now assume that B is 1.

= (A – 1/2)^2 – 5/4

5/4 = (A – 1/2)^2

Sqrt(5) / 2 = A – 1/2

Therefore, the golden ratio, A = [1 + sqrt (5)] / 2

Note that this makes A approximately 1.62. (it is an irrational mathematical constant)

Intricate in its beauty, elegant in its simplicity.

Near the Parthenon was once the statue of Athena overlooking the city.

Shown above: Athena's perch from which she offered Victory to the Athenians, now long vacant.

Previously, this building was home to statue of the grey-eyed goddess who watched over her namesake and in her raised hand held Nike, the winged goddess of victory. While the statue is long gone, perhaps it is time for the Greeks to look after her and her fellow Olympians as they recover and protect artifacts of the past.

Athens Metro

2011-04-07T08:04:00.001-04:00

The Athens Metro is one of the newest and most beautiful metro systems in the world despite (or rather because) it took an immensely long time to build. This is because as they dug, they had to stop because they often ran into old archeological ruins. Then they would stop digging with machines and archeologists would dig with toothbrushes. The metro plan was equal parts archeological dig as it was construction site.

However, the result is a brilliantly new metro system that includes exhibits and finds from their digs and the duality continues: it is both museum and metro station.

The fare is 1.40 euro for a 90 minute multi-trip ticket which needs to be validated. A day pass is 4 euro.

Greek Hospitality

2011-04-06T05:44:00.010-04:00

I tend to have a recklessly casual travel style when it comes to recreational travel (e.g. going to Mt Olympus when it’s closed because I won't be back for a few years). While this often tends to get me lost, I'd be lying if I didn't also admit that this has led to some of my best experiences while travelling.

Having said that, it can also lead to me being at the mercy of the locals. While I'd like to think I have the street smarts to get by, I also have to admit that the kindness inherent in the Greek culture makes it particularly easy.

Maybe it’s because they have had a seafaring culture for centuries / millennia and are accustomed to disoriented visitors arriving from around the world, but I have always had a deep respect for Greek hospitality, an important theme in the Odyssey by Homer, one of my favourite books. This also reminds me of one of my favourite scenes: Book VIII – The Games, when Ulysses meets Euryalus.

Context: Ulysses is lost. It's the whole premise of the book. And throughout, he experiences either kindness or evil from different characters. In this book, he arrives on the shore of the House of Alcinous. During the feast, the blind poet, Demodocus, sings songs of Ulysses' exploits, ironically, not knowing he is in the room. Ulysses' weeping is noticed only by Alcinous, who proceeds to distract his guest by suggesting they compete in athletic competitions instead.

During the competition, Alcinous's son, Laodamas, the best boxer, thinks to invite Ulysses to participate and Euryalus foolishly insults him when Ulysses politely declines due to the ravages of “infinite trouble” he’s experienced making his heart heavy for home. Ulysses proceeds to throw the heaviest disc the furthest distance (without even taking off his jacket) and proceeds to challenge anyone and everyone to any contest of their choosing (except for running due to his old age, and except for Laodamas, Alcinous' son, of course, respecting the role of the host's family). Alcinous politely calls Euryalus an idiot and calls for more festivities, hoping to prove to Ulysses that while the Phaeacians were not known for their athletic prowess, he was hoping to prove that they are exceptionally hospitable: “extremely fond of good dinners, music, and dancing”.

After acknowledging the spectacle of dancing, Ulysses compliments Alcinous, to which Alcinous responds by asking the twelve chief men (thirteen with himself) to give him “a clean cloak, a shirt, and a talent of fine gold”. Having disrespected Ulysses by supposing him to be unathletic and breaking the Greek code of hospitality to foreigners, Euryalus apologizes by giving him a gift: a beautiful bronze sword. Ulysses, making peace with his new friend, accepts the gift graciously, remarking that he hopes Euryalus will never have need of it.

(Read the original as this paraphrasing doesn’t do justice to the original poetry. Plus, there is a hilarious adulterer's story of warning told by Demodocus of Hephaistos, Venus and Aries)

As my highschool english teacher once explained, the concept of gift giving was important in Greek culture in that it emphasized the role of both gift giver and acceptee. It symbolized the greatness of the giver to be able to offer a gift as well as the importance of the recipient by being shown respect through the offer of a gift.

Climbing Mount Olympus

2011-04-05T11:06:00.011-04:00

This is an instruction guide for anyone who might be interested in visiting Mount Olympus on a student budget. I thought I should write this down as I had unusual difficulty getting details and will probably be back here again sometime. After arriving in Thessaloniki, I got instructions, searched the internet and otherwise asked around for how to climb Mount Olympus:

Getting to Litohoro from Thessaloniki

From Thessaloniki airport, take the 78 bus into the city (it goes along Tsimiski street), buy the two ride ticket which costs 1 euro (allows two trips within 90 minutes if I read the instructions correctly)
From Thessaloniki, take the 31 bus from Egnatias street (one major street north of Tsimiski)
Take the 31 bus to the end of the line to Makedonia bus station
Go to the booth for KTEL (Greece public transit, similar to Greyhound) Platform 4 – Litohoro (or Litochoro, multiple spellings)
Buy a ticket (student fair is for Greek students only), one way was 8 euro, return was 14
Go to Platform 4 and take the bus (it is quite frequent, between one or two hours per bus)
The bus stops at Katerini (Don’t get off)
The ride to Litohoro is about an hour and drops you off in the city center

Note: There is a KTEL bus from Athens to Litohoro too. I don’t know where it leaves from, but I’ll find out tomorrow when I go to Athens from Litohoro.

Litohoro

The entire climb is along the E4 International Walking trail. Here you have two choices:

Choice 1: Scenic climb From Litohoro to Prionia

From the city center (the water fountain where the KTEL bus drops you off), walk straight past the Hotel Aphrodite and go right, past the residential housing, school and cemetery and past the power / utility plant (There are some dual language signs pointing the way to Olympus National Park).

You will reach the first gate which has signs saying “Olympus National Park”. The climb from Litohoro to Prionia is through the gorge of Olympus, and takes between 4.5 to 5 hours (or more if you take your time, relax and take photos) to go up. There are beautiful cliff faces and crystal clear waterfalls.

Choice 2: Skip with Taxi to Prionia (cost 25 to 30 euro one way, 20 minute drive)

If you come to Litohoro in the off season (season this year starts May 13th), then the refuges will be closed and your best bet is to climb the gorge. It is absolutely beautiful and mildly challenging. I promise you will enjoy it's undulating terrain. However, many people "cheat", take a taxi to the top and climb down or climb up and hitchhike down. It is a 5 hour hike one way afterall.

Above: Like Mount Kinabalu in Kota Kinabalu, Sabah, Malaysia (which I plan on doing again with a friend of mine this summer), you can expect to see a lot of this on your way up.

If you come to Litohoro when the refuges are open, then take the taxi to Prionia as it will be taxing enough just to make it to the refuge which is the midpoint from Prionia to the peaks of Mt. Olympus.

People often give advice to “book in advance”, but I was unable to find any good websites or information on ANYTHING, transport to Litohoro from Thessaloniki, accommodation etc.

I’m currently staying in the Hotel Mirtos in Litohoro which is charging me 30 euro a night (keep in mind this is the off season, I think I’m the only guest and they are currently under construction so I have no idea how much it costs when the tourists come in the on season). Tel 23520 81398.

Apparently, Refuge A (which from what I gather is the best one to be in) can be reached at 23520 81800. They spoke English when I called.

Good luck!

Cheerio!

2011-04-02T18:16:00.000-04:00

Later tonight (or, more accurately, early tomorrow morning) I will be flying out of London for Thessaloniki, Greece for my last course: Service Management Field trip, a consulting based project where we work with local companies. While the class doesn’t start until the third week of April, I’ll be in Greece and surrounding countries travelling.

So I apologize in advance if there are few posts between now and then. But who knows? In the country that spawned famous philosophers and mathematicians, maybe there will be some inspiration. Plus, I still have a few small assignments to complete for MCT.

Being Made Whole in Bankruptcy

2011-04-02T18:09:00.001-04:00

In our discussions in our Managing Corporate Turnarounds class during our financial restructuring session, I got to thinking about what it would take to be made whole in a bankruptcy scenario. While the hard math will tell you that it is impossible in the short term (EV = 80, Net Debt = 100), I began to think back to the PIK and using a high yield to restore value in the future. So my question became this: If I hold the debt of an insolvent company, what can I negotiate to help me restore value? The most obvious solution is to renegotiate the terms of my debt which will probably result in me taking a haircut (discount) on the principal or face value of my debt. However, we’ve acknowledged that in scenarios where people become riskier, obviously the company’s related securities should bear a higher return. So my question then evolved to: If I have to take a discount of X percent, what additional spread Y would I have to earn in order to be made whole in N years. It turns out:

FV x (1 + kd) ^ N = FV x (1 – X) x (1 + kd + Y) ^ N

However, this assumes that you can break even with (or more accurately, catch up to) where your security would have been if the company had not defaulted to begin with. After playing with these numbers, however, it was quite clear that even with a small discount (say 20% discount), the spread Y had to be astronomically (unreasonably) higher in order to have any chance of being made whole relative to the standard debt, so I thought it would be unrealistic not to include a factor which accounts for the value lost:

FV x (1 + kd) ^ N = FV x (1 – X) x (1 + kd + Y) ^ N + Value Lost

In trying to understand what these numbers mean, I looked at Value Lost / FV as a proxy for the default rate of this type of security in distress which is obviously closely tied to the actual economic circumstances of the company. In the graph, it is reflected by the distance between the Standard Debt curve and the PIK (Realistic) curve.

Also, Y can probably be determined by looking at the spread between similar bonds with different credit ratings (dropping from BBB to C for instance).

X is reflective of the economic scenario (so if EV was 80 and Net Debt was 100, X would be 20%). It is also reflective of the negotiations, as well as considering a discount in order to liquidate the current assets of the company.

Another problem is also that once a company switches from PIK to cash sweep, its risk profile drops and it stops earning high yields, dropping the return on capital and therefore making it impossible to “catch up”. Also, a bank which was happy to finance your debt will not be interested in converting neither into a mezzanine structure better suited for hedge funds nor into equity.

This model is similar to the VC model of predicting the failure rate using the discount rate except in reverse. It is also similar to the interest rate parity (IRP) model and boot strapping by using compounding to determine where you would have / should have been otherwise as a benchmark for where you are going.

I guess the real lesson is that bankruptcy is really expensive and that being made whole in this scenario is difficult, regardless of the financial engineering and patience, although these two factors can be used to ease the pain.

Managing Corporate Turnarounds - Part II

2011-03-31T13:34:00.000-04:00

Wednesday

Often when things go wrong, people are inclined to fire the management. However, in the real world, things are hardly ever that simple. Firing management, like anything in turnarounds, is decided on whether or not this action will speed up or slow down the turnaround. Besides packages given to executives on exit, there is also a great deal of institutional knowledge that they take with them. There is a counter balance to understanding the value they bring through their experience versus the inertia they create against the changes required. This is particularly true in SMEs as well as family owned enterprises where the institutional knowledge is often not formalized (pricing mechanics, customer relationships etc.)

Also, with the separation of the chairman and CEO roles, it is possible that a power divide coupled with an inappropriate strategy may have smart people being told to chase bad strategies. One remedy which is often used is an immunity period: the idea that employees in a turnaround situation have a window of opportunity to identify any potential problems. This allows an honest analysis of problems without reprimand and realigns expectations (Are we going to make the numbers? Are our margins as good as we expect? Are we doing things right? Are we doing the right things?) Because a new team is put into place to fix previously created problems, it is not appropriate to assign current problems to new management. However, eventually, whether or not these issues were created by you initially you will inevitably begin to wear them if you don’t fix them soon enough or don’t manage expectations of the company and all stakeholders.

Thursday

Like in any business strategy, there are two major things to keep in mind in a restructuring: operations and financing. For operations, it is necessary to check if the overall business strategy works (are people buying your product and do you have a viable business) and if you are able to profitably deliver (are our margins good or are we chasing low quality customers). Also from a financing perspective, it is important to understand the liquidity constraints of the enterprise. For example, what is an appropriate financing structure to keep the company alive while providing adequate and appropriate protection and returns to current and new capital providers?

One such useful tool is the paid-in-kind (PIK) security. It is a type of mezzanine high yield debt that doesn’t pay a coupon. Typically, these types of securities return 14 to 17%. They return higher than senior debt because they are subordinated but they don’t require cash payments which allow the company to maintain its liquidity for short period of time when it’s heavily cash strapped. However, what usually happens is this is coupled with a cash sweep. To use a structure like this in this circumstance is tantamount to saying: “We understand you are strapped for cash now, so you don’t have to pay us immediately, but we want an appropriate return for taking this risk that’s more similar to equity if things recover. However, we still want to be paid sooner rather than later and when you have any excess cash, you will give us everything you have and we’ll consider you less risky and ratchet down your interest rate to reflect the change in risk.”

Artistry with Dr. Hilary Austen

2011-03-29T21:07:00.003-04:00

Tonight, there was a Rotman panel discussion hosted at the Savoy Hotel in London by our dean, Roger Martin, on “Artistry Unleashed: Pursuing Great Performance in Work and Life” written by Dr. Hilary Austen. They had a great discussion on how our current educational system seems to focus heavily on quantitative knowledge potentially at the expense of qualitative knowledge which, although by definition difficult to measure, plays an important role not just in decision making, but our ability to perform well in different environments.

Vetran integrative thinkers can probably also recognize the concept of model tension between these two ideas and can appreciate that the conversation between the panelists with Roger facilitating lead to interesting perspectives and topics being raised (eg. the role of analytical versus intuitive recognition for diagnosis performed by doctors).

Afterwards, there was a cocktail reception with the opportunity to speak with people connected to the Rotman community in London through a variety of different channels: students like myself, alumni, business partners, patrons of business publications etc.

Managing Corporate Turnarounds

2011-03-29T20:25:00.004-04:00

This week, I’m taking a block week course (one week intensive following the 10 week standard course period) at LBS: Managing Corporate Turnarounds. So far this course has actually been really interesting, with us looking at business cases for salvaging distressed companies and learning about the mechanics and considerations of struggling businesses.

Unlike my undergraduate strategy course, which I nicknamed “doom and gloom” because the distressed companies in our cases never seemed to recover, this course talks about different cases that were successfully turned around using a variety of different techniques to improve operational efficiencies and use financial tools like LBOs to capture the upside.

We’ve also had great guest speakers come talk about their specific experiences and their perspective on different aspects of turning companies around (shedding assets for cash, improving operations, recovering debt, how to identify target companies etc.) One of our requirements in class is to summarize some key learnings from the class, and in a similar fashion to the Latin America study tour which had a similar component, I plan on using this blog to jot a few notes for me to recall later as I compile my thoughts:

Monday

In turning a company around, it is important to understand where control lies. Since equity is flirting with bankruptcy, it may lose control to the debt holders. Some debt investors may be holding “grenades”, the intent to liquidate their holdings ASAP when a trigger event happens (broken covenants, default etc), and may not be interested in salvaging the company, even if there is potential to recover equity value because they just want to unwind their positions.

Companies need to have good strategies when it comes to M&A, otherwise they can fall victim of a vicious cycle: accretive acquisitions increase EPS (albeit in an inorganic manner) and can give false impressions of growth, which could potentially boost the P/E multiple. A higher P/E multiple gives the company expensive equity which it can use as a better transaction currency for buying other companies (low P/E) and still be accretive. This is a vicious cycle if the M&A is not well integrated with substantial delivery of synergies and/or overpays for targets. This typically occurs in new industries where there are a limited number of potential buyers (targets with low P/Es as there is no other mechanism for exit) and the industry is consolidating into larger players (large strategic buyers displace financial buyers niche shopping).

Another version of the problem above is when companies which are asset-light use M&A as a backdoor for raising leverage. Services companies cannot raise leverage in a traditional manner because they have neither hard assets nor collateral to borrow against, so they can acquire companies which have higher leverage ratios to boost their own ratios. Also, this type of reckless acquisition can divert focus from the core business. In turning around companies which have fallen along this path, one of the immediate remedies is to spin off non-core assets for cash.

Tuesday

When you are on the buyside for any company (not just distressed companies for turnaround), it is important to have multiple targets in the pipe, not just for the more obvious negotiation leverage points, but to prevent yourself from getting too much deal heat over one deal and to avoid negotiating against yourself and your emotions.

Negotiating a transaction involves much more than a “price”. There are terms of payment, the structure of the compensation, workouts, milestones, terms and conditions. A price which is seemingly too high can be restructured to be paid out overtime so that the undiscounted amount remains the same, but the risk and cash outflows can be spread over a longer period with the appropriate covenants and milestones.

Travelling in Europe

2011-03-24T08:35:00.004-04:00

The bizarre truth is that it’s actually cheaper to visit other parts of Europe than it is to stay in London. With the end of the term (and MBA program) upon us, many students (exchange especially) are planning a variety of trips before the academic program is over.

(Shown above: Bull fight, La Plaza de Toros de Las Ventas, Madrid, Spain)

So far this week, I’ve been to Madrid, Spain and Bordeaux, France. I'm travelling with a few students from LBS and we are driving down the coast of the south of France and into northern Spain, visiting coastal towns as we make our way down and are currently San Sebastian, Spain. My French has been a bit rusty, but enough to decipher menus, make orders, ask directions and generally get around. It has been almost 5 years since my CFES days.

(Shown above: Chateau Margaux, Bordeaux, France)

(Shown below: San Sebastian, Spain)

Having visited Lisbon, Portugal and Rome, Italy there is only one other country I need to visit to collect my PIGS set: I plan on visiting Greece in early April for my final block week course: Service Management Field trip, a consulting project based in Thessaloniki, Greece.

I have always enjoyed Greek mythology, especially after reading the Odyssey in high school which was one of my favourite books of all time. I will certainly enjoy spending time in Athens visiting some of the ancient ruins. Greece is also home to many famous mathematicians and philosophers that derived such elegant concepts such as the approximation of pi or the golden ratio. I'm really looking forward to the trip.

Emerging Markets - China

2011-03-15T17:06:00.003-04:00

We just completed our final presentation in the Emerging Markets class taught by Linda Yueh at LBS. Our group chose China, and we did a cross section of important business factors and how they affect investment decisions and mechanisms into the country. While the presentation was performed by myself and my classmate Tim, the other team members contributed greatly to the material and their preparation was reflective in the cohesive and comprehensive story we presented. It was easy to present the highly refined material to create an investment thesis branching across a broad range of industries and tell a story about how specific companies would benefit or be hindered by government regulations and financial market mechanisms.

Tim did a great job going into the details of the domestic business environment with some personal anecdotes from some of our team members’ recent trip to China. JEMBAs (aka January intake Executive MBAs) at LBS are required to a week intensive in a foreign country and three of our JEMBA team members visited China together.

I think we represented the hard work and analysis of our team well.

Planned Obsolescence

2011-03-14T12:09:00.003-04:00

With the last week of the core 10 week period upon us at LBS, things have dramatically started to pick up. I have my final exam for Behavioural Finance on Thursday which promises to be challenging.

I've also got a final PEVC assignment due in-class tomorrow where our take home individual case will also be released. Also, tomorrow, I have a big presentation for Emerging Markets with the final group and individual papers due by the 18th.

What a roller coaster it's been, not just here but in the MBA program in general. It seems like not too long ago, I was stepping into Rotman for the first time. After taking a look back at this blog, I've realized how much I've enjoyed my time at Rotman. And with the end of the program so near, it's time to plan wrapping up of all the loose ends.

I have two more classes left, block week courses (one week intensives) which I'll be taking between now and the end of April. However, this provides me with ample opportunity to take advantage of the easy access to Europe and as such I'm planning trips with some of the fellow exchange students between now and when I leave. My last two classes are Managing Corporate Turnarounds (last week of March) and Service Management Field trip, a consulting project where our class will be in Greece (jokingly referred to as "exchange on exchange") which will be my final class of the MBA program.

I'll continue to blog as interesting ideas pop up in the last few classes and probably put up a few nice pictures from my travels, but I expect that I'll put up a final post around the end of April as I head back to Toronto.

FEI Competition

2011-03-09T13:45:00.003-05:00

Apparently, our final round presentation for the Financial Executives International Case Competition is now available online. Unfortunately, I can't embed it into the blog, but I can include the link below:

http://www.feicanada.org/cfo-tv.php?vid=22&page=2

Enjoy!

KKR at LBS - Socially Responsible Private Equity

2011-03-09T13:29:00.004-05:00

Just now, we had the inaugural talk for the Socially Responsible Private Equity talk given by Ken Mehlman, KKR's Global Head of Public Affairs. He was the Chairman of the United States Republican Party, campaign manager for President George W. Bush's re-election campaign, and White House Political Director. He was also a classmate of Barack Obama at Harvard Law.

He gave a great talk on how social responsibility is integral to sustainability of a business, especially one with patient capital in PE. One point he made which I thought was particularly poignant seemed to echo the ideas of Integrative Thinking. He said that there are generally two common models with regards to social responsibility:

Corporate CSR – Where a company makes contributions to organizations outside of its operations that show it cares.
It focuses solely on strong operations and generating business returns to the bottom line without much consideration for social responsibility.

He mentioned that KKR takes a third approach, and that it integrates social responsibility not just at some abstract corporate or portfolio level, but right down to the alignment of its operations to produce. Examples of this would include involving a broader definition of stakeholders versus shareholders such as environmental agencies and unions in determining the best course of action for a company’s future operations and how it should be run.

Besides some of the insightful deal war stories, future PE trends and industry knowledge he shared, he also gave great advice on what he thought it took to be successful which was well received by the crowd.

There were a host of excellent questions asked by the crowd in the Q&A session as well as the cocktail reception following. I’m looking forward to the next event hosted by the PEVC club.

MAJUP

2011-03-08T02:04:00.002-05:00

The past few weeks have been pretty busy with a variety of events. LBS hosted its first combined TMT conference with the technology and media club on Friday Feb 25th with speakers on topics such as new revenue streams for IPTV and the forecast for cloud computing. There was one particularly interesting speaker who equated using cloud computing to storing informational currency in a bank. While you appear to be giving up control in the form of a physical box hosted on site, the security and convenience of cloud computing is similar to withdrawing money from an ATM.

That weekend I had some friends from Barcelona visiting (they were going to pursue careers in the TMT space) and they also had the fortune to stay for Tattoo, a school wide celebration of cultural diversity with artistic and gastronomic displays. The entire school was set up with tents as students prepared food native to their homelands wearing traditional dress and putting on performances to display their artistic talents.

This past weekend was spent in Lisbon. With exams coming up, it was a good opportunity for the exchange students to have one big go at a trip before many of us run off at the end of the 10 week term period. Time seems to have flown by as we are already in March.

YCIF London – First Conference Call

2011-02-21T16:17:00.002-05:00

Today the YCIF in London hosted its first conference call. The speaker was Mr. Carlos Leitao, Chief Economist and Strategist at Laurentian Bank of Canada. He gave some great insight into the outlook of the Canadian economy by providing some colour as to the major macro indicators and the story of what was going on behind the key performance metrics.

I'm looking forward to the next conference call which is slated for Wednesday of next week. The topic will be the European state of the economy for 2011.

Weekends in London

2011-02-21T08:57:00.005-05:00

The past few weekends in London have been interesting.

This past weekend the LBS International office hosted a London sightseeing event on a red double decker bus touring around to see the major sights: London bridge, tower bridge, London eye, Buckingham Palace, Big Ben, Parliament etc. The tour ended at the British Museum where we had lunch and a few of us went to check out the exhibits which include the famous Rosetta stone.

On Sunday, a few of the exchange students also went to see a Fulham football match at Craven College. We were sitting in the “Home/Neutral” section and it was a great match.

The weekend previous was the big Private Equity conference held by LBS on Friday with speakers from major firms like KKR, TPG and The Carlyle Group.

Another exchange student and I also ventured into Oxford to the Said Business School to attend the Enterprise Africa conference with various speakers on topics such as Private Equity, China and India's relationship with Africa etc. Speakers were from Goldman Sachs, Bank Of Maurituis, MTN and other top banks and industry representatives.

While there, we also had the opportunity to check out Christ Church, the place where the main hall of Hogwarts was filmed for Harry Potter.

Bid / Ask Curves

2011-02-10T22:58:00.010-05:00

At the break in behavioural finance, I was speaking to a prop trader about the mechanics of the market. This reminded me of my short trading exercise in the Rotman Finance Lab with the Trading Simulation software.

In microeconomics, we discuss demand curves and how they are based on individuals with different levels of willingness to pay. So as the price increases due to a supply curve shift right (less supply), the quantity demanded decreases.

In markets, this is a little more transparent if you look at the bid / ask lists. These lists show the prices and volumes people are willing to buy and sell for. The other unique thing about the capital markets, is that there is actually a set number of securities (assuming that banks do not issue or buyback securities in the short term, supply is price inelastic based on total float) and that investors can be both buyers and sellers (short term suppliers and consumers) of securities. Actually, a better way to put it would be they can either hold or release securities (demand based relationship).

If their intrinsic value (IV) of a stock is above the current market price, they will buy the stock. If their IV is less than market, then they will sell. And in an exchange market, that is exactly the case (orders, unless removed before execution, are commitments to buy or sell at the stated price).

Shown here is an illustration of a “complete” market. This assumes that everyone’s IVs are included, that there are no hidden orders and that people’s opinions won’t change with the market price (a snapshot by nature). The current ask price is $8.00 and the bid is $7.75. As people’s sentiments change (or new investors are introduced into the market), orders to buy are satisfied at $8.00 and orders to sell are satisfied at $7.75. If all the potential sellers at $8.00 are taken up, then people can only buy the stock at $8.25 and the stock price goes up. Note that the differential between bid and ask is a proxy for market liquidity, as the lower the transaction fee to enter and exit a position the lower the cost of trading the security.

Also note that the steepness of the curve is a good proxy for potential volatility as well. Because if the slope of the curve is steep over a variety of prices, it means that the market doesn’t necessarily agree on the price. And if a few people cross the line from one side to another, the price can change quickly and dramatically (shown below):

Bridge to Value

2011-02-08T21:44:00.012-05:00

One graph I've seen which I thought was clever was a breakdown of change in EV. This brings together many other details I've learned about M&A, LBO's and transactions in general.

Previously, I mentioned a framework for PE deal success, but it is easy to cut into more detail if necessary and really define and put a mathematical value to "synergies".

For example: After a transaction, we've increased sales by 21%. How does that affect EV? Well on one hand, you've immediately realized a 21% increase in revenue. After you account for associated costs with that increase in revenue (ie. You've sold more widgets, but it still costs you money to make those widgets), what do your future growth prospects look like as a result of this new growth (ie. Should you trade at a higher multiple? Have you gone from "boring" to "exciting"? Or is it just general market conditions?)

Previously, you had:

Market Cap = $100
Shares outstanding = 100
Price per share = $1

Debt = $100 (@ 5%)
Excess Cash = 0

EV = $200

Revenue - $100
COGS - $40
GPM = $60

Op Ex - $20
EBITDA = $40

DA - $10
EBIT = $30

Interest = $5

Tax = 40%

NOPAT = $18
NI = $15

Therefore:

EPS = 15 cents

P/E = ($1/$0.15) = 6.67x

EV/EBITDA = ($200/$40) = 5.00x

Let's tell a story: The 21% increase comes from opening a new line of products. You are selling 10% more products by introducing a new product line and this new product line actually increases your revenue per unit (across the board) by 10% (110% x 110% = 121%). All margins are the same.

What should we do? Bring everything down to the EBITDA level:

Now:
Revenue - $121
COGS - $44 (10% more products at same costs)

GPM = $77

Op Ex - $22

EBITDA = $55

DA - $10
EBIT = $47

Interest = $5

Tax = 40%

NOPAT = $28.20
NI = $25.20

EPS = 25.20c

(Magic happens - Which we will explain shortly)

New Price per share = $1.80

Market Cap = $1.80 x 100 shares = $180
Debt = $100
EV = $280

P/E = ($1.80) / ($0.2520) = 7.14x
EV/EBITDA = ($280 / $55) = 5.09x

Analysis:
So a lot is going on. The price of the equity and the enterprise has changed, but how can we do a cross section such that we know exactly where all the value is being driven from?

How much of this value is because of leverage (hint, we didn't change amount of leverage)?
How much of this value is simply because we are operationally better?
How much of this value is because we have a "brighter future" (better growth prospects)?

Step 1: Value from leverage arbitrage:
No change = 0

Step 2: Value from "synergies":
Total EBITDA level changes: $40 to $55 or $15
At a multiple of 5.00x (previous multiple), value increased is $75

Step 3: Value from "Brighter future"
Brighter future (higher multiple) due to either market conditions or expected future growth:
$55 at 5.00x versus at 5.09x = $55 x (5.09 - 5.00x) = $5

Total value created: $75 + $5 = $80 (note total increase in value of EV / Market Cap)

Next step, look closer at Step 2:
Change of $40 to $55 is created by:
$21 in Revenue (Price +10%, Volume +10%)
$4 in COGS (Volume + 10%)
$2 in Opex (Volume +10%)

For a $21 increase in revenue, keeping margins constant we would have expected an increase of:
$8.4 in COGS (40% of revenue) and $4.2 in Opex (20% of revenue). COGS is lower by $4.4 and Opex is lower by $2.2 versus what is expected.

Note we mentioned we can sell products for 10% more across the board.
This created value for existing product base (at EBITDA level) of
$110 - $40 - $20 or $50 versus $40 creating $10 of additional EBITDA level value (makes sense, increase topline growth by 10% without changing expenses / sales volumes results in increase of EBITDA by 10% of revenue)

Also, selling an additional 10% at old price we would expect:
$10 (additional sales) - COGS ($4) - Opex ($2) or $4

But selling new products at new price: Gain $1 (similar to math shown above)

Total change in EBITDA: $10 + $4 + $1 = $15
At 5.00x
$55 or ($10 + $1) x 5.00x of EV is generated from selling at a higher price
$20 ($4 x 5.00x) of EV is generated from selling new products (higher volume)

Above is what the bridge would look like if a PE firm had 60% ownership and management had 40%.

Note, this framework is iterative and can be applied across multiple product lines to help do a break out and sum of the parts analysis for companies to see where value is hidden in undervalued divisions.

Also note that as an interesting aside, if you were actually to build out a proper DCF model of this (using some basic business assumptions holding margins constant etc.), your short term growth rate would have to be adjusted upwards in order to come to the same intrinsic valuation that would justify the higher multiple.

Flight of Fancy - Market Price for Courses

2011-02-08T21:19:00.006-05:00

So it turns out I’m not entirely crazy.

Obviously, one of the benefits of going on exchange is to meet new people and learn from new experiences. Previously, I had posted on a flight of fancy, where I wondered what would happen if we extended the idea of our bidding system at Rotman to the “next level”. Well it turns out that elective bidding at some other schools can be slightly more complicated.

Talking to some students at other MBA schools, they have more “progressive” (market driven, while not entirely "pure") bidding systems for courses, where you can actually buy and sell courses for a profit (expressed as a gain in “points”) where you bid for classes early and then “sell” them at a later date when their point value has increased.

The only short coming of their system (from a market perspective) is that there is only one form of “liquidity”. The only way to truly “exit” the market? Take a course. There is no other way to liquidate these points. This could easily be solved if you could simply transfer the points to another student (a secondary market would develop and even create an OTC market price in $$$'s for course points).

And then you would have a market answer for the question: “How much is the margin worth to take the elective course you want?”

YCIF – London Chapter Inaugural Event

2011-02-04T09:42:00.009-05:00

Yesterday, the Young Canadians in Finance organized their inaugural event in London at the Royal Automobile Club. The guest speaker was from the Canadian High Commission and spoke on the strong relationship between the UK and Canada and how Canada’s focus on increasing value added exports such as talent in the financial services sector was helping to improve Canada’s name abroad, especially in the light of our strength in the recent financial crisis.

The RAC was a beautiful club and it was nice to meet with fellow Canadians on this side of the pond. It was also surprising what a small world it is, as some of the people I had met had worked with some of my fellow Rotman students back on Bay Street at Canadian banks as recently as this summer.

My friend, Mathieu Bouthillier, has been a driving force for organizing YCIF’s presence in London, the first chapter outside of North America. He’s got a great line up of events including a series of guest speakers and social events which will be happening later this month and in March which I am looking forward to and will certainly attend.

It’s amazing some of the contacts you make and what you can learn just by having conversations with intelligent hardworking people with similar interests and it was a pleasure to be a yesterday’s event.

Chinese New Year in London

2011-02-04T09:18:00.008-05:00

xin nian kuai le; gong hai fat choi; selamat tahun cina baru

Earlier this week, a few of the exchange students at LBS went to celebrate Chinese New Year in typical fashion, over a splendid meal, in London’s “alternative” Chinatown near Queensway. While the lineup was fairly long (we ended up waiting for 45 minutes due to exceptionally high traffic volume), the service was otherwise very good and the meal was delicious.

Earlier that week, I was also lucky enough to catch a dragon dance show in London’s official Chinatown near Piccadilly Circus while buying some groceries.

The Globe and Mail featuring Rotman Students

2011-02-01T09:30:00.005-05:00

My classmate, Alejandro Macareno, recently spoke with the Globe and Mail on why international students come to Canada and how they add value to the classroom through their unique experience and perspectives.

Being from Venezuela, Alejandro gave helpful comments on a case we had studied in our Managing People in Organization class way back in Q1 of first year when we looked at a Canadian bank acquiring a bank in Latin America and the merger of cultures. He certainly added some meaningful context to our discussion as someone who was born and raised in that part of the world.

You can listen to him speak on the Globe and Mail website on the experience of international students in Canada.

Some of my other classmates from Rotman featured include:
Ajay Jayarajan
Khaled Nounou (The same Khaled who was on the Islamic Finance ICP team)

Recently, I asked my classmates for guest posts about their unique experiences at Rotman and posted the series.

Islamic Finance – Executive 3 Day Program

2011-01-30T17:01:00.004-05:00

Today, I presented remotely from London at the Islamic Finance Program, hosted at Rotman for the Executive Program in partnership with Bennett Jones. This was the final component of our Islamic Finance ICP. The team lead by Walid included myself, Arash, Shahzad, Khaled, Kashif and Noureen and we presented our materials to the executive program participants.

With the rise of Islamic finance, I’ve had some interesting conversations with people I’ve met while on exchange at LBS regarding Sharia compliant financial structures such as the various types of sukuks we’ve been analyzing.

Our spread analysis drove quite a bit of interest for people who were interested in what a Sharia compliant structure would yield and the market conditions for doing such an issuance. Even before our presentation, I had the opportunity to answer some basic questions regarding the pricing spread between Islamic instruments versus conventional.

Senatus Populus Que Romanus

2011-01-26T08:54:00.006-05:00

Quando sei a Roma vai dove vanno i romani
"When in Rome do as the Romans do"

One of the benefits of doing exchange, particularly in Europe, is the ability to travel to new places, see new things and meet new people. This weekend I visited Rome flying on EasyJet from Gatwick. Thankfully, my teammate for Private Equity / Venture Capital was a good sport, agreeing to meet well in advance of an assignment due for next week to finish it as I would be incommunicado for the weekend.

I visited the Colosseum and the Roman forums where ancient ruins stretched across parks. Even the city itself was sprinkled with fountains, statues and monuments. It was impossible to travel for even a few meters without encountering a plethora of fountains, making it surprisingly difficult to navigate the entangled narrow streets using landmarks.

Like many travellers collecting stamps on our passports, I was hoping to get a stamp from the Vatican (afterall it is technically its own country, the smallest country in the world). However, despite the tall walls surrounding the city, there was no security or passport control. The Sistine chapel and St. Peter's Basillica were very serine and it was nice to just enjoy the solemnity and gravity of the place.

The trip itself was actually punctuated more with food and wine then tourism to be honest. It was nice to just relax somewhere enjoy copious amounts of "vino della casa", putting down several "brave soldiers", and generous portions of fresh pasta and risotto.

My only regret is pushing my return so late, arriving "home" to London on Tuesday afternoon with just enough time to shower and rush to class, a mistake I will not repeat on my next excursion.

Veni, vidi, vici

Intuitive Explanation of Bayes’ Rule

2011-01-21T08:00:00.006-05:00

One of my favourite math identities is Bayes’ rule. It also occurs quite frequently in Behavioural Econ / Finance as well as integrative thinking because it is such a good (mathematically provable) example of flawed thinking and model construction.

But like any formula, if not understood at an intuitive level (aka memorizing the formula vs rebuilding it from scratch), applying the formula incorrectly will yield meaningless (and potentially misleading) results.

Bayes’ rule states:

P(A\B) = P(B\A) x P(A) / P(B)

On the surface, this formula seems to make no sense: “The probability of A given B is the probability of B given A multiplied by probability of A divided by probability of B.”

However, walking through step by step we first understand that:

P(A\B) = P(A Λ B) / P(B)

This makes sense. The probability of A happening given that B has happened is the area encompassed by A and B (gray) divided by the total universe of probabilities, B (red and gray), because we are told that B “has happened”.

So from here we can also understand that:

P(B\A) = P(A Λ B) / P(A)

Which is simply the same rationale as the one above. However, using algebra, we can see that:

P(A Λ B) = P(B\A) x P(A)

And combining the two formulas, we get the original:

P(A\B) = P(B\A) x P(A) / P(B)

Example provided in class:
Of patients entering a chest clinic:
Event A – Person has cancer
Event B – Person is a smoker

80% of people with cancer are smokers: P(A\B) = 80%

10% of patients have cancer: P(A) = 10%
50% of patients smoke: P(B) = 50%

If you knew someone was a smoker, what is the probability they have cancer?

Solution:

Most people would over estimate the number, due to various incongruities in the probabilities, namely because such a high percentage of patients with cancer are smokers at 80%.

However, the math shows us that P(B\A), the probability of finding cancer given that you know someone is a smoker is (80% x 10%)/50% or 16%. Although it is higher than the average of 10%, is still relatively unlikely that they have cancer relative to what most guesses anticipated.

You'll notice that the answer is heavily affected by the rarity (and relative elasticity) of event A, or the chance that someone has cancer to begin with.

Behavioural Finance and Bounded Rationality

2011-01-20T19:02:00.004-05:00

Whether fortunately or unfortunately, human beings do not behave in perfectly economically rational ways which makes them very difficult to predict. Even with our most complex models accounting for a variety of different factors, there is a high degree of volatility not explained by our multifactor regressions and the models they produce.

Behavioural finance (along with it's fraternal twin, behavioural economics) aims to better understand how humans make decisions that are non-optimal in the strict finance / economics definition and don't comply with what academics would have us anticipate as expected behaviour.

While this course is particularly interesting, what did strike me as noteworthy was that a lot of the foundation material for this course is based on the same principals as integrative thinking taught in our FIT class. In fact, it seems as if we've been doing a review of FIT, focusing on how humans make errors in judgment and build sub-optimal mental models based on well documented shortcomings in how we think.

In fact, some of the examples used in the class are lifted from the exact same material presented to us in Q1 of our first year highlighting anchoring effects, neglecting regression to the mean, availability heuristic, rational probabilty assessments, hot hand and gamblers fallacy etc.

A Framework for Measuring PE Deal Success

2011-01-19T04:49:00.003-05:00

The Analyst Exchange and Marquee group showed us how to build LBO models and the basic framework for showing how LBOs generate returns to private equity holders through 3 mechanisms:

Leverage arbitrage – Increasing leverage and paying down through cash sweeps
Operational arbitrage – Improving operations to generate higher earnings / EBITDA
Multiple arbitrage – Selling the company for a higher exit multiple

Of the three, the most meaningful method of generating returns is the second, operational arbitrage. Leverage arbitrage can generate returns, but is not a strategic differentiator when it comes to a bidding process (unless you have some unusual advantage in raising capital) and multiple arbitrage is simply based on market conditions. However, operational arbitrage is directly related to value creation and is the reason why a strategic buyer can afford to pay more than a financial one.

While this is useful notionally, how can we use this to build a framework to understand how each dimension performs in a deal? In my Private Equity and Venture Capital class, they proposed the following framework and example:

So the total gain in equity value is 78.9 (112.9 – 34.0)

Return from leverage arbitrage is actually negative because debt increased rather than decreased at -9.2 or (4 - 13.2) and contributes to the equity gain by -12% (-9.2 / 78.9).
Return from multiple expansion is 27.3 or (13 x (9.7 - 7.6)) and contributes 35% (28.6 / 78.9)
Return from operational improvement is 60.8 or (7.6 x (13 – 5)) and contributes 77%

Using this information, you can benchmark the deal against different performance metrics and determine if the deal generates equity gain simply because of leverage or multiple expansion versus creating value by improving operations.

[Rotman] 5 Great Speakers at Rotman

2011-01-16T08:00:00.002-05:00

[Rotman Series: 1, 2, 3, 4, 5]

Jaime is a part-time student in the MBA program at Rotman. He has worked in the sports media industry since 2002 and is currently Manager, Digital Media for the Canadian Football League. He and I went to the Latin America study tour in May last year. He was gracious enough to do a write up for me on his favourite guest speakers which follows:

By Jaime Stein

One of the first things you notice when you obtain an e-mail account at the Rotman School of Management is the sheer volume of e-mails from a guy named Steve. At first it can be overwhelming, but if utilized wisely, it can be your ticket to an exclusive roster of speakers. Steve and his team are the masterminds behind the A-list speakers that regularly visit the Rotman School.

The hardest choice I have to make each week is which speakers I will NOT listen to. This is a good problem to have because choice is always welcome when working full time and attending school part time. I simply don’t have the time to listen to every speaker that passes through Rotman. However, in almost three years, I have been privileged to listen to close to 100 guest speakers.

Most of the speakers that I have seen have delivered outstanding talks, but for the purpose of this blog I present five of the best speakers I have listened to during my time at the Rotman School:

1. Paul Martin – Former Prime Minister of Canada

Imagine you are in your second semester of a three-year MBA degree and you are studying Macroeconomics. A large focus of the course stems around Canada’s macroeconomic policies during the 1980s and 1990s; specifically the country’s battle with debt and inflation. One day you find out that the man behind the plan to battle inflation will be speaking at your school. That would be like a young basketball player having the opportunity to shoot hoops with Michael Jordan and ask him for tips.

Fortunately for our macro class, Mr. Martin came to speak at the Rotman School one morning and for about an hour took us through his plan that brought Canada back from the brink in the mid-‘90s. Following his talk he took time to speak to each of us and share some more personal insights and war stories from his time as both Finance Minister and Prime Minister. This was one of the great days at school that left me wanting to explore a subject further.

2. Isadore Sharp – Founder, Chairman and CEO of Four Seasons Hotels and Resorts

One of the main selling points of the Rotman School is its focus on Integrative Thinking – the theory coined by the current Dean, Roger Martin. In one of his books on Integrative Thinking (The Opposable Mind), Martin focuses on the story of Isadore Sharp and his path to building the greatest luxury brand of hotels in the world. In many of our classes we study the Four Seasons Model for customer service and other best-in-class management techniques. We were fortunate to have Mr. Sharp visit the Rotman School and explain firsthand how he went from one Four Seasons hotel in 1961 in Toronto to operating a chain of approximately 100 properties worldwide.

For anyone with an ounce of entrepreneurial spirit this was a motivating discussion. You could see the passion, courage and drive that Mr. Sharp possessed to launch his vision and stay true to it along the way. Any successful company will create a competitive advantage – however, these are eventually replicated by the competition over time. When people are your competitive advantage, it becomes truly sustainable as Mr. Sharp has proven. While other hotels provide outstanding service, none of been able to match the formula created by the Four Seasons.

3. Rahaf Harfoush – Digital Strategist and Author

It was November 27, 2008 when Ms. Harfoush spoke (for the first time, I believe) at the Rotman School. There was lots of hype surrounding her talk that day because Barak Obama had recently been elected President of the United States and Ms. Harfoush was a part of his wildly successful digital media campaign. I also remember this talk vividly, because it was one day later on November 28, 2008 that I joined Twitter. A lot in my personal and professional life has changed since that defining moment – all for the better.

The topic of conversation at Rotman that day was, “Applying Barack Obama’s Social Media Strategy to Your Brand’s Communications Needs” and it was Ms. Harfoush’s talk that became the inspiration for a lot of what we have done at the Canadian Football League over the past two seasons in the social media realm. To me, this is what an MBA program is about – an exchange of ideas to help stoke peoples’ imagination and potential. I’m glad I made time to attend her talk that day.

4. Michael Lee-Chin – Founder and Chairman of Portland Holdings Inc.

In October, 2009 I attended the Rotman School MBA Leadership Conference in downtown Toronto. It was a star-studded event with speakers like George Butterfield, Co-President of Butterfield & Robinson, Beth Comstock the CMO for GE, Don Morrison, COO of Research in Motion, Robert Deluce the CEO of Porter Airlines and Michael Lee-Chin, the Founder and Chairman of Portland Holdings.

Mr. Lee-Chin is one of the most engaging speakers I have had the pleasure to listen to in person. Mr. Lee-Chin spoke for about an hour on a variety of subjects including how to create wealth. He focused on a small number of blue chip businesses with long-term growth potential. But he was adamant that you know and understand where you are investing your money. One quote from Mr. Lee-Chin that sticks with me is, “If you don’t understand what you own, are you investing or speculating?” This is important advice that too many people continue to ignore this day and age.

5. Jay Hennick – Founder and CEO of FirstService

Mr. Hennick spoke to our class recently at the Rotman School. He runs FirstService, a company that provides services in commercial real estate, residential property management and property services and generates about US $2 billion in annualized revenue. Mr. Hennick told us his amazing story of how he achieved his current standing atop a multi-national company. He got his start with a company he ran as a tenth grader that brought in an income of $200,000. Yes, you read that correctly – he was in grade 10.

His key message was focused on people management; what he believed was the differentiating factor for the success of his current company. His “Partnership Philosophy” states that impact players must have more than a salary and bonus invested in the business; they must have an equity stake. His company focuses on aligning employees’ interest with shareholders in building long-term value. This was both fascinating and eye opening for most students who believe this is hard to do in a company of 18,000+. Yet FirstService continues to succeed. Listening to Mr. Hennick and his passion for success was rewarding.

As you can see, there are some overarching themes from these speakers such as focusing on people and establishing long-term strategies. But ultimately, each of these speakers is among the leaders in their field and that is why I feel fortunate to have spent the past three years at the Rotman School. The access to these great minds alone was worth the price of admission – well almost!

Arrived in Britannia!

2011-01-13T20:47:00.004-05:00

I've arrived and moved in to my flat which is right across the street from London Business School which is convenient. Apparently, we happen to be very close to some famous addresses on "Baker street":

We've met our exchange classmates from around the world and are slowly going around meeting the 400 students in each of the 2011 and 2012 classes. There are some impressive resumes and experiences of the small sample of people we've met so far.

[Rotman] Ghana, another perspective

2011-01-13T08:00:00.004-05:00

[Rotman Series: 1, 2, 3, 4, 5]

Darshan is an another good friend of mine from Rotman. He holds Bachelor of Technology, Applied Electronics and Instru, University of Kerala and also spent this last summer in Ghana.

Darshan has graciously written me a summary of his experiences which were from a different perspective than Harman’s (Darshan's had a bit more of a engineering / technology flavour). It follows:

Snapshots from Ghana – An Emerging Nation in West-Africa
Looking back, my 3-month Ghanaian summer experience provided a fairly deep understanding of the opportunities and challenges present in this sub-Saharan African country – one that is at the cusp of a developmental inflection point. Along with a fellow Rotman MBA student and four other Canadians, I was working for a non-profit organization located in Kumasi. The organization (SMIDO) dealt with supporting close to 80,000 people - a community of artisans, auto mechanics and metal workers in Suame Magazine (sector of densely populated metal workshops) – to gain market access and facilitate an ecosystem required for businesses to compete with the formal sector.

I arrived in Kumasi with a hazy idea in my mind about the place – drawing pictures and parallels with my home state Kerala, located in southern India. Those ideas were redrawn in the first few hours after I reached there. More than anything else, my first impression of Kumasi was that of a highly dense, busy, loud urban community trying to make ends meet. Beyond that first impression, however, the environment has a noisy vibrancy colored with great optimism about a better future.

Here are a few highlights from my visit there:

Industry and Client Site Visits: My tryst with Ghanaian business began with an introduction to Ghana's gold mining sector. After meetings with gold miner Central African Gold, who was once our client, I got a chance to tour their gold mine pits and extraction plants to see their operations first hand – this was quite an interesting piece of the visit. In another meeting with Red Back Mining, a Canadian gold miner, what was memorable was hearing the head of the firm’s social responsibility group talk at length about Red Back Mining's efforts to establish lasting relationships with the mine’s displaced community. Red Back has invested considerable resources in helping the local community in which it operates and asked our expertise in partnering with them to design skill development and training programs for apprentices from those displaced communities.

Economic Growth Prospects: Apart from mining, another key growth prospect in Ghana is information communication technology (ICT). Most high school children in urban centers have a Facebook account and there is an increasing trend toward being connected to the world - through mobile phones or the internet. Along with the addition of the focus on energy resulting from the recent discovery of sizeable oil reserves off the coast of Ghana, the country also has a Green Revolution going on where local farmers are getting more yields and income from their crops.

Talks with Ministers and Entrepreneurs: Some of the chats with Ghana’s politicians such as the Minister of State for Environment revealed a message of prudence concerning the potential perils of newfound natural resources and a desire to expand unions with other West African countries. A chance conversation with social entrepreneurs like Ashley Murray (Waste Enterprises) gave me a sense of profound optimism of the future of the private sector. The fact that Ghana enjoys a reverse brain-drain, wherein internationally educated Ghanaians and foreign nationals are increasingly returning home from North America and Europe to begin careers that will design enterprise development seems to support this growing optimism.

Despite the different rendezvous with entrepreneurs, business people and ministers, the time spent with the people within the non-profit was perhaps the best part of my summer. The long bus rides and trips were memorable as they included time to talk about our cultural experiences. Created by the common bond of intense cultural experiences – with visits to the beaches of Cape Coast, Elmina Castle slave trading post, Kakum and Mole National Parks and the countless soccer games we watched together - the personal connections forged during the trip will no doubt be more valuable to me and a true measure of my impact.

I departed Ghana very impressed by the hospitality of the Ghanaian people, the immense potential of the country and the depth of the challenges that will present themselves along this nation's path to growth.

[Rotman Series: 1, 2, 3, 4, 5]

Flying out for Exchange, London Business School

2011-01-12T17:56:00.002-05:00

I think it's finally hit me. I'm flying to London. I'm sitting in Pearson airport taking advantage of the free wifi, wrapping up a few things and my excitement level is steadily increasing. Geoff Wylde, the other Rotman student going on exchange to LBS has been busy, having left last week. I've been getting emails from the international exchange students who are already there and their social plans for their time in the UK.

I'm really looking forward to being at a new school and meeting new people. As with Rotman, it will be another opportunity to meet likeminded individuals and participate in various events (I would be severely disappointed if my participation in events like case competitions dips even a little bit).

MBA Games was fun, with Rotman winning the Spirit Q&A awards. The Rotman organizing team did a phenomenal job planning our participation this year, only our second year participating. It occurs to me that this is the largest student event I’ve ever been to; even CFES Congress and CEC were only about 220 students, whereas the MBA games were 662 from 20 MBA schools across Canada. I also met some old friends from the FEI case comp, RIM and even junior high! Small world.

The winning team was University of Alberta, so it seems that next year’s team will have an interesting trek to the next games assuming they can get funding support. The host of the games is the previous year’s winner, unlike the CEC which uses a bidding system.

[Rotman] India, US, Canada, and Africa

2011-01-12T08:00:00.003-05:00

[Rotman Series: 1, 2, 3, 4, 5]

Harmanpreet is an international student from India and holds a Bachelor of Computer Science and Engineering degree from the National Institute of Technology in Jalandhar, India and will be joining Deloitte’s technology consulting practice once he is finished his MBA at Rotman.

Harman had the interesting experience this past summer of working in Ghana, Africa and I’ve asked him to provide a short reflection of the experience which follows:

Before joining Rotman School of Management I was working as a technology consultant in one of the leading investment banks in New York.

To fast pace my career I decided to pursue MBA and because of some personal reasons chose Canada as place for that. I chose Rotman because of its excellent faculty and its location proximity to finance and consulting industry. I must say it has been an eye opening experience. The people I met, their vast experience, the work they have been doing in past amazes me.

I decided to take a bit different route to enrich my MBA experience. While working full-time in professional world it is very difficult to get an option of doing something completely different.

During summer break, I went to Ghana to work for Suame Magazine Industrial Development Organization (SMIDO). It is an industrial development organization of the biggest industrial cluster in sub Saharan Africa. SMIDO is an umbrella organization of various businesses in Suame Magazine area and is committed to ensuring the development of Suame Magazine into a technologically advanced industrial estate and representing the various economic groups that operate within the area.

Working in a under developed economy is a real challenge. But the satisfaction that I got from work that changes someone’s life is incomparable and this feeling kept pushing me to put more and more efforts into whatever I was trying to achieve.

My most important contribution while there was to approach a gold mining company with a proposal to sponsor apprenticeships for people displaced by their mining operations. It was ecstatic when the mining company accepted the proposal.

After summer experience my whole approach to business has changed. I used to think that business means making more money for you and for your shareholders. Now I believe that purpose of business should be to benefit human society rather than to accumulate wealth to satisfy egos.

It was an experience that I will cherish for rest of my life.
-Harman Singh

[Rotman Series: 1, 2, 3, 4, 5]

[Rotman] What country starts with "A", but doesn't end with "A"?

2011-01-11T08:00:00.003-05:00

[Rotman Series: 1, 2, 3, 4, 5]

Arash is a old friend of mine back from my McMaster Engineering days. After pursuing his Masters of Engineering, he decided to come to Rotman to do his MBA and will be joining Booz & Co in the Middle East when he is finished here. We also went on the Latin America Study tour together in May of last year.

During my visit on the Middle East study tour, we visited the Aga Khan foundation. The Aga Khan Development Network (AKDN) is a group of development agencies with mandates that include the environment, health, education, architecture, culture, microfinance, rural development, disaster reduction, the promotion of private-sector enterprise and the revitalisation of historic cities. AKDN agencies conduct their programmes without regard to faith, origin or gender.

One of their impressive projects was their work with Roshan, a unique telephone company that performed to the same standards of private enterprise with regards to profit generation, but also imposed high standards to their relationships with governments regarding transparancy. Arash had the opportunity to work with Roshan this recent summer and he's written a post about the experience which follows:

Little did I know what adventures awaited me upon starting my MBA at Rotman. Of course it would open new doors and new opportunities, but where exactly was still to be determined. However, I knew that I would have preferred an international experience, as a result of which I also signed up for the Latin America study tour for which we visited Brazil and Argentina. When summer recruiting came around, I applied to both domestic and international opportunities. Of the postings that came up, the one that stood out the most was the one by Roshan Telecom in Afghanistan. Having been born in Afghanistan, I jumped at this opportunity to go to back and work there. I was very young when I left Afghanistan so I never actually got to see the country, so this opportunity was ideal – international work experience in an extremely challenging work environment and the ability to see the country and my extended family.

Naturally, working there was not easy, and definitely not for the faint-hearted. The challenges were numerous – adapting to the local work culture, working with expats colleagues from 20+ countries, and learning about the telecom sector as well as the market in Afghanistan. Imagine doing business in a country where there is little to no rule of law, very little regulations and a largely illiterate population. In addition to this, security restrictions were extremely tight and violations were swiftly dealt with (one intern was sent home for breaking curfew rules). However, these restrictions were definitely necessary – while I was working there, there were numerous incidents in Kabul, including a suicide bombing, roadside bombing, rocket attack on the airport, riots and street fighting. The challenge was to try to reduce the possibility of being at the wrong place at the wrong time, and really, the wrong place could be anywhere, and the wrong time could be any time. Despite this, I did managed to connect with relatives there (they had seen me when I was born but I never met them), and made visits to a couple historic sites in Kabul as well as Herat. It was definitely interesting to see some of the places that my parents saw when they grew up, although things now were radically different. Over the last 30 years of war, the population of Kabul swelled from 400,000 to over 4 million and you could definitely feel it.

My project at the company was as interesting as it was challenging. I had no background in the telecom sector. More specifically, I was looking into a type of fraud that occurs in the sector, which made matters even more complex. My project was to analyze internal detection and treatment mechanisms as well as to come up with potential strategies for preventing this fraud from taking place. After spending days learning about this problem and gathering data, I spent the following weeks working on analyzing the information to develop actionable strategies that could be used to reduce the impact this fraud had on the company. I found it extremely interesting, and I found several areas of improvement that could positively impact the company by improving their fraud strategy.

After work we were shuttled back from the office in downtown Kabul to our guesthouse just on the outskirts of the city. Life was actually less complicated there than it is here – we had room service that cleaned our room every day, we had laundry service and buffet style breakfast, lunch and dinner. I absolutely loved the fruits there – the best grapes and cantaloupes I have ever had in my entire life. After dinner people hung out in their rooms or relaxed out in the courtyard, watched the Indians/Pakistanis play cricket, worked out, played basketball or played pool. All in all, not a bad life, if it weren’t for the volatility of the country.

Overall, it was a fantastic opportunity to work in a challenging environment and with an interesting company. I never thought that coming to Rotman would have enabled me to work in Afghanistan, but it did, and I am definitely grateful for that. In addition to this, the study tour was definitely very interesting and also helped solidify my interest in working abroad. Moving forward, I will be working full-time for a top tier management consulting firm in the middle-east, an opportunity which also came about through Rotman. Not only did my MBA at Rotman open new doors for me, but it opened up the entire world to me – the world truly is my oyster.

[Rotman Series: 1, 2, 3, 4, 5]

[Rotman] Why is an MBA taking a Geology class?

2011-01-10T08:00:00.005-05:00

[Rotman Series: 1, 2, 3, 4, 5]

As I’m preparing to go to go to LBS, I’m dedicating this week to Rotman: What makes us different? Over the next 5 days, I’ll be putting up posts about what differentiates Rotman the school and the students, not just locally, but also within a global context.

The first post is about Shree, a brilliant friend and colleague at Rotman who I respect very much. He also had a very unique experience; an opportunity which I think is often over looked and should be highlighted. Specifically, that Rotman is part of the University of Toronto, but more than just having access to U of T’s libraries, sports facilities and resources, as U of T students, we also have access to elective courses outside the business faculty.

Shree had the idea of taking an engineering geology course because he has a natural interest in commodities and wanted to have the insight and gain a higher level of understanding of mining.

I’ve asked Shree to write a honest review of the course (GLG 1442) and I’ve included it below:

Do you have a specific career in mind that demands you know things other than the 4Ps of marketing or the time value of money? If so, you might want to look into picking up a course outside of Rotman in that area.

My job involves looking at investments, and since Canada is often referred to as the “mining capital of the world”, I felt that a geology course would add value to my education. With this in mind, I took the GLG 1442 course, which is offered through the Earth Sciences department at UofT. My review in a nutshell:

Learning accomplished: 9/10
Relevance of the course to everyday business: 6/10
Organization of the course: 3/10
Degree of difficulty: 8.5/10

Lets break down the components above into more detail –

Learning accomplished: If there was one objective in my mind for taking this course, it was to learn more about geology. The course was highly education towards this objective. I was able to learn about different types of deposits, how they are formed, what the typical characteristics of such deposits are and where a certain type of deposit can be found. I doubt I would have been able to achieve all this learning outside of the classroom within a four month time frame. As a result, I give a very high grade for the learning accomplished.

Relevance of the course to everyday business: Let’s face it. Many of you will never have to deal with a mining company in your career. This reduces the relevance of the course right away. However, for those who want to become involved in equity research or investment banking that could benefit from having some knowledge of geology, this course should provide a decent level of groundwork. Relevant topics include different types of deposits for specific metals as well as the grade, tonnage characteristics of these deposits. There is very little coverage regarding the costs related to mining these types of deposits, which makes this course somewhat less relevant than it could be. Secondly, there isn’t much coverage regarding the economics of mining either, which further erodes the relevance.

Organization of the course: If you are expecting a course which is organized in a manner similar to Rotman, you are in for a huge shock. A combination of handwritten overheads, no powerpoints and old school slide projectors makes the organization of this course difficult to follow. Additionally, there are in class handouts which are meant to supplement the handwritten notes, which further make it difficult to keep track of what might be going on in the course. The structure of the course is fairly loose since materials covered tend to skip many parts of the notes and does not strongly tie into the textbook. In fact, I never had to even use the textbook.

Degree of difficulty: The major fact of this course is that this is a graduate level geology course. The majority of the students taking this course are mining engineers or geologists. You will be expected to be on the same level as these guys pretty much from day one. Given the lack of a foundations course, this puts a student at a huge disadvantage. Therefore, if you are taking this course with the expectation of getting a good mark, you may be better off sticking with a Rotman course. If you are expecting to take this course as an elective, you are definitely better off taking a Rotman course. Compared to a typical Rotman course which is 2 hours of lectures per week, you will find that this course demands 5 hours of class time (2 hours of lectures + 3 hours of lab time). There is also a lab exam in this course which is unrelated to the materials covered in the exam, which means you are really taking an equivalent of two courses. The takeaway here is, be prepared for a difficult course and have some prior knowledge of the materials before hand. This will be the difference between struggling through this course and potentially failing this course.

Conclusion: For the people who have a genuine interest in mining, this course is highly useful. This course would be much more useful if it were better organized and had a better tie-in with business concepts such as IRR, project financing etc.

[Rotman Series: 1, 2, 3, 4, 5]

Game On!

2011-01-07T18:13:00.003-05:00

We just arrived at the Westin Harbour Castle in Toronto for the MBA Games hosted by Schulich. The Rotman team has arrived and we are just getting sorted in our rooms before finding a quick bite to eat and attending the opening ceremonies later tonight.

The hotel lobby is filled with students from other schools and already we are piled up with great deals of swag: Rotman branded sweaters, t-shirts and track suits from our sponsors, snacks from General Mills, KD from Kraft, water bottles from RBC, etc.

Already, I've had a chat with someone I met at FEI competition from the Ryerson team. There is a lot of energy in the air as everyone is excited to meet with other students from different schools over the weekend.

I'll be in one of the academic competitions, the Case Competition, where only hint is that the topic will be "Organizational Management". We'll be spending all of Saturday (starting early) on the case competition. Sunday has many of the sporting events so we will be cheering our team mates as they compete in various sporting events.

Modeling a Down Payment as a Call Option

2011-01-06T12:03:00.002-05:00

There was an interesting idea that came up in our discussion of Islamic Finance that got me thinking. While not directly related to what we were doing, someone mentioned the idea that a down payment was modeled like a call option which I thought was quite clever.

Consider this, you can:

put down a payment for the right to purchase the asset
elect to walk away from this right, forfeiting the down payment, or
pay the *remaining amount* and purchase the asset at the appropriate time

This is very similar to a call option, with only one exception:

Note that in a down payment, you are paying the remaining amount, not the full amount of the asset. So if you were to use a call option to model down payment, you would have to adjust the strike price down by the premium (down payment) because the down payment is applied to the purchase price of the asset.

So imagine that the value of your asset changes after you’ve paid the down payment. If it goes up, you can continue your purchase (and possibly even sell your asset for a profit, assuming its liquid enough) or you can elect not to buy it if you’ve taken a huge bath (maybe even the market value dropped by more than the down payment amount).

Back from the Holiday

2011-01-06T11:52:00.003-05:00

Well after a well deserved break, all the students are back.

First years are in their Negotiations class which odd for me as I didn’t do this last year due to the Middle East study tour, but now I see what it was like with the Atrium constantly being flooded by ambitious MBA students trying to get better deals in their exercises. There have also been requests for help with preparing for recruitment week which is coming up next week and some postings already up.

Even second years are at school, many having the clever idea of taking an intensive or two to lighten their final term course load.

Yesterday, we did a presentation for our ICP in Islamic Finance. Arash and I did a presentation on two comparable securities, one conventional and one Islamic and we showed they were strategically and operationally comparable (same industry, business model, enterprise value, capital structure, debt ladder, similar maturity, seniority and economic conditions, but different country and terms) and we analyzed the yield, adjusting for country risk and broke down the spread accounting for liquidity risk, minor maturity differences and increased cost of capital related to Sharia compliant terms.

This material will be used as part of Rotman’s new Executive MBA program class on Islamic Finance. While we aren’t quite finished with our work, the next step being to propose a term sheet for what the conventional financing would look like if it were Sharia compliant, I’m very happy with our progress and the insight we were able to bring into this new product class.

ICP Islamic Finance - "Conventional" Analysis

2010-12-16T16:48:00.003-05:00

This morning we had a working session for our ICP - Islamic Finance with some lawyers, a corporate banker and professors. The two teams presented their analysis of the conventional financing structure of the primary security instruments used to finnace our projects. Under this conventional analysis, we looked at the costs of capital and the associated terms related to these types of paper with the intent of understanding the requirements need to make them Sharia compliant.

We also had great explanation from a senior lawyer regarding the structuring and "asset-based" (versus "asset-backed") nature of nominating (rather than selling) assets under a Special Purpose Vehicle (SPV) in order to comply with the necessary requirements of Islamic finance. We had considered the capital gains implications of a sale leaseback transaction, as well as understood how an asset and capital intense infrastucture project would look similar under an adjusted EV to EBITDAR metric regardless of the off-balance sheet financing that may potentially be required.

We have a solid understanding of the work requirements due before our next meeting in early January (before I fly off for London). We also had an opportunity to fire questions back at the professionals in the room in terms to learn what were the appropriate resources for generating comparables for analysis and benchmarking of our theoretical capital structures based on similar Sharia compliant instruments and current market conditions.

Some of the best advice we got:

Understand the difference between "asset backed" versus "asset based" and how that affects your ability to issue Sharia compliant instruments
Be aware of tax implications of capital gains/losses in a sale leaseback transaction
Like any financial security, understand the key characteristics of seniority and expected return for a sukuk issuance and understand market appetite for these structured products

What Makes Rotman Different? A foray into the world of Business Design

2010-12-16T15:23:00.010-05:00

In anticipation of our trip to LBS, Geoff and I have been asking ourselves: “What makes Rotman different?” In discussing this idea, one of the key points at the top of the list was business design. This week, I’ve had the pleasure of attending various events over at Design works where members of a university in Singapore are undergoing certification for Business Design.

On Tuesday, Geoff and I attended a working session with Anita McGahan discussing the evolution of demographics across different geographies and the implications for the future of the health care industry around the globe. With our guests present, we learned a great deal about the specific differences in the Singaporean culture and life style and were impressed by the innovation produced by their ambitious programs.

This exercise was particularly enlightening for me, not only because of my previous work as a Wireless Consultant for RIM in the healthcare communication and process optimization space, but also to learn more about the business design process.

Today, I also attended a talk given by my class mate and president of the Business Design club, Jason Huang, at Design Works for our Singaporean guests. He gave a very inspiring speech about the current state of business design at Rotman as well as a road map to the initiatives he and his team are putting into place to further develop the program at Rotman at the academic and extra-curricular levels. I am particularly impressed by his attitude, aiming to be the top club at Rotman. I think he also has demonstrated that he has the will and ability to execute on these new initiatives, launching business design more prominently into the spotlight.

He also had a great point about case competitions where “the idea isn’t just to try to do well, but more importantly to learn” a sentiment which I would like to echo and I think reflects my personal motivation for participating in various case competitions, including those not necessarily related to my chosen profession.

What is Business Design @ Rotman? Find out for yourself by watching the YouTube video below:

End of Classes, Start of Exams

2010-12-13T21:59:00.005-05:00

Last week marked the end of classes for second years and many of us had our first exams today (with the exception of the options class which had their exams last week due to a scheduling conflict with the professor).

Some of my classmates have been thoughful enough to remind me that this is my "last class at Rotman" or my "last exam week at Rotman" as I'll be leaving for exchange in Jan for London Business School. It has started to become more real for me as I think I have found some good accommodation (deposit to be sent tomorrow).

I just wrote the exam for Business Analysis and Valuation tonight (a four hour exam... Yikes!) This week I also have Financial Management on Wednesday evening, Corporate Finance on Thursday and Mergers & Acquisitions on Friday. Thank goodness my ICP in Islamic Finance doesn't have an exam, although it does have work that will stretch over the holidays.

I'm looking forward to the upcoming break, MBA games in Jan and flying out for exchange!

DCF

2010-12-02T16:17:00.011-05:00

With summer recruiting coming up for first years in the next few months and with many of our second year finance courses requiring us to do some form of valuation (Corp Fin, Financial Management, Mergers and Acquisitions, Business Analysis and Valuation etc.), I thought it might be useful to post an "academic" quality discounted cash flow model as a reference.

There are some basic comments in the cells which explain some of the assumptions.

Discounted Cash Flow Model

Discounted Cash Flow Guide

For a more advanced version of forecasting (including working capital schedule and depreciation schedule), check out my Chapters LBO model.

Mergers and Acquisitions – Final Project Surprise

2010-12-02T14:33:00.001-05:00

Wednesday morning was the presentation date for our final project in M&A. The Wednesday morning class was given the acquirer of Bombardier and told to pitch an appropriate target for the deal. My team had worked very hard to put together a robust deck for our pitch.

While we were told that there would be two “industry judges” coming to judge our presentations, I was quite pleasantly surprised to see two senior Scotia Capital bankers whom I worked with over the summer (one from M&A and one who covered industrials).

It was fantastic to see them again and our class certainly benefited from their comments. Having worked with these two senior bankers at Scotia, I appreciated their comments and learned a great deal from the high caliber of their questions and the responses of my classmates.

Multi-Factor Models – Applying the Lessons Learned from the Numbers

2010-11-25T11:00:00.003-05:00

In Finance 1 last year, we were introduced to the idea of multi-factor models (MFM) originally explained by Fama and French as an alternative to the traditional Capital Asset Pricing Model (CAPM) for assessing systematic risk. Additional factors include small versus big (SML) and value versus growth (HML).

In our Business Analysis and Valuation class, we discussed a merger case in which a large company acquired a smaller company. We talked about what would be the best way to approximate beta. The method I used (which was the best method I could conceive, I’d be happy to hear criticism or suggestions otherwise) was to weight the betas by market cap and take an average.

However, there was some discussion about the fact that one entity was much smaller than the other. While we were having a conversation of what that would actually mean, I would suggest a mathematical method for expressing the quantitative effect of size, using FF’s MFM.

1. Express both company’s re as a three factor MFM
Re1 – RFR = beta1 (Rm – RFR) + betas1 (SMB) + betav1 (HML)
Re2 – RFR = beta2 (Rm – RFR) + betas2 (SMB) + betav2 (HML)
Take the larger company’s size beta and apply it to the smaller entity
betasnew = betas2
Recalculate re for both entities
Re1new – RFR = beta1 (Rm – RFR) + betasnew (SMB) + betav1 (HML)
Re2new – RFR = beta2 (Rm – RFR) + betasnew (SMB) + betav2 (HML)
Take a weighted average (by market cap) as the expected return of the combined entity

By taking the larger company’s size beta for both, what you are saying is that you expect the smaller company to have the size “characteristics” of the larger entity. I might even be more appropriate to add the size factors (Would that be appropriate? As the MFM is a linear regression, is it appropriate to add these factors?) and use that for new return on equity for each entity as it relates to the combined entity.

betasnew = betas1 + betas2

While there are some significant assumptions which are required for this to work, it is the best solution I can conjure based on information given. I would really appreciate any additional ideas for creating a more robust model.

Abnormal Earnings Method – Not Entirely Useless

2010-11-25T10:33:00.007-05:00

When we were introduced to the Abnormal Earnings method in Business Analysis and Valuation, I was decomposing the math formula which constructs the value of the equity. As far as I was concerned, it didn’t really tell us anything we didn’t already know through a equity based discounted cash flow (FCFE discounted at re).

However, there was an interesting scenario in which this method actually told us something unique. First the formula:

Market Value = Book Value + (NI1 – re*BV)/re + (NI2 – re*BV)/re^2 + …

Nix is Net Income in year x

BV is book value

While in theory, this formula should return a similar value to an equity based DCF, one unique value is that the valuation is relative to book value, rather than strictly looking at only cash flows. Essentially, what it is saying is, the company is worth it’s book value, PLUS it’s “abnormal earnings” where abnormal earnings are the earnings you get in excess of what you would expect (re).

So in looking at a company that is trading below book value, I used to think that it meant that the market did not believe in the company’s management to perform (the company was burning cash). But it doesn’t just have to be that the company is on a “crash” course. It could also just be that the company is not performing as “expected” that is to say there net income is not necessarily negative, but simply less than what is expected.

MBA Games - Rotman Team Kick off

2010-11-18T18:15:00.000-05:00

Rotman is putting together a team for this year’s MBA games, hosted by Schulich from Jan 7th to 10th. I saw how much fun they had last year that I missed because I was on the study tour and wanted to make it a priority to participate if possible this year (postponing my flight out to London).

Last year’s team was the first time Rotman had competed in six years I’m told and was put together last minute. However, building on last year’s interest, the efforts and energy of our current organizing executive was quite obvious as they were eager to bring us all into the fold to compete and have fun at the games.

To our competitor colleagues at other MBA schools: “See you at the games!”

Write-Up of Intangible Assets

2010-11-18T15:04:00.005-05:00

In M&A, acquiring a company requires you to pay a control premium above the current market price to capture a majority of the shares outstanding needed to own the company. Usually, a company’s equity trades at values above book value (the idea that the sum is greater than the parts) and that there is value creation.

So in an acquisition scenario, there are a few considerations. Firstly, the market price is above the book value. Secondly, the purchase price is above the market value. The cumulative amount by which the purchase price is above the book value is referred to as “excess”. This excess is usually allocated in two ways: Good will and Write-up of Intangible Assets.

Purchase Price > Market Price > Book Value

Purchase Price = Book Value + Excess

Excess = Goodwill + Write-up of Intangible Assets

Intangible assets would normally be amortized, but in this scenario they do not provide a tax shield. This makes sense because if you could amortize them you would essentially be double counting your DA expense (or depending on what type of asset it is, such as Intellectual Property, your R&D expense). Also, if you could count this as an expense, this would provide a tax shield against your acquisition premium and promote higher premiums.

Another consideration is the effect on asset based leverage ratios depending on where you allocated the write-ups in value. One note was that in companies which depend heavily on leverage (and where asset based ratios can significantly affect ratings and therefore borrowing rates), there is a tendency to try to write up assets rather than allocate the excess to goodwill (also for “optics” reasons).

Aside: Any buyer that is offering an acquisition price below the current market price should seriously reconsider their position. Although we've seen this unique situation with the recent Potash deal, there are some obvious problems with offering a purchase price below the market price.

Financial Executives International – 5th Best in Class Competition

2010-11-16T15:41:00.005-05:00

On Saturday, a Rotman team composed of myself, Shree, Fei and Matt Literovich competed in the Financial Executives International 5th annual Best in Class Competition. The case company was HudBay Minerals. Unfortunately, we placed second, behind Alberta School of Business.

The competition was intense, as many of the teams worked late into the night on Friday to put together our decks and get a few rehearsals in before scrambling to get a few hours of shut eye. The next morning, our names were drawn for presentation order and we found ourselves in the seventh spot.

Matt Literovich was phenomenal understanding potential legal issues related to mining and commanded the attention of the room when he spoke of precedent case law.

Fei gave a detailed account of all the organizational issues we could expect as HudBay Minerals grew and followed our acquisition strategy.

And Shree’s knowledge of mining and dissection of potential target companies gave us an exceptionally high level of credibility.

All three were exceptionally strong in both the presentation and the question and answer period and this short description does not do justice to the quality of our presentation.

While we were very disappointed that we didn’t take the top spot, the event itself was challenging and very entertaining. Judges from the competition included top executives from HudBay Minerals, USGold, OTPP, Mercator, a justice and many other top professionals. Definitely a great experience, I would recommend any MBA student to attend this competition.

Competitions Week – RMA Case Comp

2010-11-16T15:23:00.003-05:00

Last week was very heavy for case competitions and presentations (hence the lack of posts).

On Wednesday, we had the Rotman Marketing Case competition. The case was based on the Pan America (Pan Am) games, where we were asked to create a strategy for how to engage university students to participate in the Toronto 2015 games.

One key insight from our team was that the university students of 2015 are currently high school students, so we took a two pronged approach:

Engage high school students now and use their 40 hours of volunteering to instill a culture associated with sport based mentorship.
Create the university infrastructure that would allow these students to be received into such post-secondary institutions.

We proposed that as the system developed, this program could follow PanAm games host cities and was modeled similar to "Right to Play" and eventually leverage the Olympics brand to become international and increase the sense of legacy of the games beyond just physical infrastructure.

While we didn’t place in the competition, it was interesting to see what other teams pitched as it was a fairly open ended question and there were plenty of unique solutions proposed by the other groups.

Islamic Finance - International Consulting Project

2010-11-09T20:10:00.007-05:00

A new initative at Rotman (although you wouldn't know it as it has simply exploded this year) is the International Consulting Project. Laura Wood, Director of International Programs, has started a new research type project that engages students to work with professors on international topics. Some countries involved are the G20, Middle East, Israel, Africa and potentially others.

I myself am participating in the Islamic Finance ICP with Walid Hejazi, the professor who leads the Middle East study tour.

Yesterday, we were invited to attend the kick off event for the Islamic Finance EMBA course which will be offered in Jan 2011. The keynote speaker was David Dodge, Senior Advisor, Bennett Jones and former Governor of the Bank of Canada. He spoke about the growing interest in Islamic finance and how there it is common for people to see Shariah compliant instruments as simply "no interest" and how this superficial understanding does not encompass the fundamental rational for the structure of these products.

I am looking forward to working with my four other colleagues on this research project to look at Islamic financial instruments.

Legacy REIT

2010-11-09T18:57:00.005-05:00

In our corporate finance class today, we were responsible for presenting our valuation of the Legacy REIT IPO. We used a variety of different valuation methods and multiples to provide a range of potential valuations before recommending a price of $10.50.

My team was fantastic to work with. As we are also responsible for the RioCan valuation next week, we opted to split the group work down the middle and sort out our presentation. My team mates produced a robust DCF model which had it's assumptions firmly grounded in the economic realities of the industry. When it came to question and answers, my team mates were resilient in answering questions about reconciling the various valuation methods to resolve model tensions (the DCF says we should price higher, but yield analysis shows that we aren't generating a high enough yield to attract potential investors relative to other REITs).

In the end, it took all the strength I could muster to stop grinning like a Cheshire Cat as my team mates hammered back answers to questions by pulling up pre-emptive appendix slides and presenting a well founded case for our valuation.

As an interesting note, our professor had worked on this deal and mentioned that they had priced the deal at $10 (and that apparently, for mathematical simplicity, these units are generally priced at $10 and that the sources of funds are changed through the number of units issued - like bonds at $1000 or preferreds at $25).

Retail Experts Speaker Series - Jurgen Schreiber, President and CEO, Shoppers Drug Mart

2010-11-01T17:49:00.007-04:00

Rotman hosted another speaker series session today from the Retail Experts Speaker Series @ Rotman and the guest was Jurgen Schreiber, President and CEO, Shoppers Drug Mart Corporation. And he spoke on "How and Why Shoppers Drug Mart is Transforming its Stores to One-Stop Shopping”.

After noting that this talk was organized before the change in pharma regulations, he began with a quick history of Shoppers and the development of its stores, noting that the first Shoppers store originally had a variety of products.

He offered a breakdown of Shoppers value proposition on five key elements:

Dominate on Convenience

Differentiate on Service

Differentiate on Products

Differentiate on Experiences

Compete on Price

Why? Simple answer: Because the customer is ready for it. Real answer: “Our gut told us to do so – to create something really unique and different” & “We have the capital resources and financial strength.”

Mr. Schreiber went on to discuss mega-trends that he perceived as being crucial to the long term success of Shopper’s including: Health, Convenience, Age Complexity, Gender Complexity, Individualism, Sensory, Comfort, Connectivity and how it was necessary to understand and embraces these factors, use them in combination to differentiate and innovate in a scalable way. He also reflected on the changes in demographics in the Canadian market place such as more singles, no or less children, smaller households, aging population and multiple income couples.

Jurgen defined a modern one-stop shopping experience as needed to focus on location and opening hours, store experience, clear assortment, in-store convenience, service, product, loyalty programs and loyalty specific products, to create a “Have it all drug store”. He emphasized how it was also necessary to avoid small and mega store formats, traditional assortments, all services, and all profit pricing. He spoke about how there is a concept of “My store”: my SDM (Shoppers Drug Mart), My SDM Associate and Team, My Optimum, as part of My Neighbourhood.

There was one odd little insight in Shoppers product mix. They don’t sell fresh food, but they make an exception for fresh bread, a noteworthy exception pointed out by Jurgen. He mentioned that, in testing, customers perceive this product has being an exception as to what types of products are expected at Shoppers.

He closed by speaking about the Optimum program. A classmate I was watching the presentation with on the third floor commented that Optimum was a program that was the first of its kind. Unlike popular third party programs, or other loyalty programs, Optimum induces customers to return to the shop to pick up additional items. As an example, this is in contrast to a gas station loyalty program which just causes you to return to the same gas station to purchase something in which you have a relatively inelastic demand – gasoline and convenience goods during travel – selecting between vendors versus marginal purchases though increasing basket size and return visits – two of the key value drivers of Dilip Soman’s customer value framework.

Financial Management Presentation

2010-10-22T15:51:00.002-04:00

Yesterday, my team had our presentation for Financial Management with Asher Drory, a professor notorious for not pulling any punches and generally holding all Rotman students to a very high standard. We didn't want to disappoint.

Our case was on securitization as a form of financing. The company was a collections company which bought bad loans for pennies on the dollar and made a profit by collecting on them. However, they were being squeezed on the margins due to banks beginning to charge more for the bad debts as well as the quality and collectability of the debts shrinking.

The company was also looking to grow, and had been previously financing its growth through the securitization of it's uncollected loans (in this specialized financial industry, loans are a form of inventory, rather than as a liability in a traditional company). However, the conditions of the security were almost exactly the same as debt (monthly interest payments and principal flowthrough).

Therefore, in order to properly understand the risk exposure in the company, rather than have the financing sit off the balance sheet, we made adjustments to show what the balance sheet would look like if they were financed with traditional debt (which is not an unreasonable assumption, given the type of business risk that they are exposed to through this financing is not dissimilar). The end result is that suddenly all their solvency ratios and coverage ratios are totally out of whack. Whereas before their company had reasonable ratios (debt to equity of about 0.8x), their ratios were now about 4 to 5x.

Financial Executives International Competition

2010-10-22T15:37:00.006-04:00

On Wednesday we had Rotman’s internal competition for the Financial Executives International competition. I was part of a team of four, including Irina, Shree and Matt Literovich. The case was on Tiffany’s expansion into Japan and how they wanted to protect themselves from exchange risk. All the teams did a comprehensive analysis on the potential hedging options and the exposure. It was very humbling to see the caliber of work produced by our classmates in such a short period of time.

It was great to work with my team mates and our discussion on the financial strategy was highly enlightening. In the end, we looked at a variety of strategies including forward contracts, put options and collars.

Yesterday, we found out that we were selected to represent Rotman at the national competition which will be hosted by Ryerson on November 12th. Unfortunately, Irina will be unable to attend, but Fei has gratiously joined our team.

We are all excited at the opportunity to represent our classmates and showcase Rotman talent as well as meet MBAs from all across Canada at the "Best-in-class" competition.

Levering and Unlevering Beta - Mechanics of the Model

2010-10-15T07:24:00.002-04:00

It occurs to me that I didn't really describe the formula for levering and unlevering Beta and why it works. Let's have a closer look:

First think of any given industry. There are some major assumptions required to get levering and unlevering beta to work. For instance, a dollar invested in an industry will give a constant return proportional to it's risk (beta). This is one of the fundamental assumptions in CAPM.

Levering beta is the idea that I can amplify the result of a deal by using debt. Let's look at an example:

I'm in an industry that has a beta of 1.2

ERP is 5%

RFR is 4%

ke = RFR + beta * ERP = 4% + (1.2) 5%

= 10%

So if I invest a dollar, I can expect to get a return of 10%.

However, I can use leverage (borrow money) so that I want to experience an amplified result:

I'll invest 1 dollar, but allow borrow another dollar to invest with. So I have two dollars in play, but only one of those is mine. My return? Well, assuming you can borrow at RFR (a huge assumption), you'll gain another 10% on that additional dollar, but have to pay 4% (RFR) so you'll gain another 6% on top of your original 10% for a total of 16%. You've doubled your systematic risk by having two dollars in play. Let's check with CAPM:

Beta = 2*1.2 (twice as much exposure)

ke = RFR + beta * ERP

= 4% + 2.4 * (5%) = 16%

This makes sense. For every additional dollar you borrow at RFR and invest in the industry, you will make the spread between their returns (or the beta * ERP).

So if you borrow D, dollars (D in this case stands for Debt), versus E dollars of your own money (Equity), and because CAPM is a linear function, you can expect:

Your exposure will be based off of D+E dollars (total capital in the game - systematic risk, exposure)
But off a base of E dollars invested (the money you have invested yourself, or Equity)

So if an industry has a beta of Ba, and you use leverage D on your initial investment E, you can expect your new beta of Be, to be:

Be = Ba * (E+D)/E

Note, however, that (E+D)/E = 1 + (D/E)

Look familiar? It's the levering formula:

Be = Ba * (1 + D/E)

But there is still one piece missing. The (1-t) portion of the formula is to simply account for the fact that debt that you borrow provides a tax shield, so the final version of the formula replaces D with (1-t)*D to get:

Be = Ba * (1 + (1-t)*D/E)

Hope this decomposition helps. I noticed this relationship is very prevalent in financial calculations as Anita McGahan clarified in one of her lectures on Starbucks in first year when talking about Operating Strategy versus Financial Strategy in the Dupont Decomposition. This was something I had also wondered about previously.

Accounting – The Story Behind the Numbers

2010-10-14T15:02:00.005-04:00

It seems like the major topic for this week has been related to working capital. In our financial management course, however, there was a great example case where simply knowing the numbers is not enough.

Simplified Case Info (expressed in thousands):

Revenue = 17805
AR = 6000
Average Day’s Receivable in the industry = 59 days

Analysis:

Company’s Average Day’s Receivable = 123 days

Proposed financing solution: Collect on AR to reduce Day’s Receivable to industry average of 59 days.

If Days Receivable = 59 days, implied new AR is 2878. The change in AR would be 6000 – 2878 or 3122.

So looking at this *mathematical* solution, it seems as if the company can get a free 3 million dollars just by tightening its AR, right? Well as it turns out probably not. The reason?

Most companies define default as non-payment of debts of 90 days or more. Previously, we’ve talked about how debts decay in value as they are outstanding for longer and longer (probability of collection and bad debt expense). If you look at this number, essentially what it is saying that the many of your accounts are in default with an average age of 120 days!

Sometimes you can’t just assume you can make operational changes to reflect a reality that you want. The truth of the matter is that those funds are probably lost. The firm probably won’t collect those accounts and will incur a significant bad debt expense.

In reading more of the case, it also mentioned that the company had a “no returns” policy with its distribution channel partners. Looking at this number not only meant that they probably weren’t going to collect, but that their distributors were telling them that they didn’t want to do business with them any more (affecting their potential future revenue growth). Not only will they not be able to pull 3 million dollars out of working capital, there are some critical red flags appearing about their ability to continue as an ongoing concern.

Unlevered Beta

2010-10-13T11:46:00.005-04:00

A quick recap:
Beta of a company is determined by a statistical regression of returns of a given security against returns of the market.

As a result, "beta" usually refers to a company's equity beta or observable beta. Using CAPM, we can calculate the expected cost of equity (ke) using:

ke = RFR + beta * ERP

Where ERP is Equity Risk Premium

So what is unlevered beta and why is it important?

Well, recall from CAPM that you can change a company's capital structure in order to add leverage to increase beta and thereby increase expected return of equity (with a company's cost of equity being the investors return on equity).

Unlevered beta tells you how much a company's industry is expected to return, regardless of the leverage employed by looking at the systematic risk of an industry regardless of the financing decisions. Theoretically, the unlevered beta should be constant across companies in an industry.

Why is this important? Here is one example. You are trying to determine the cost of equity (so you can determine WACC for DCF) of a new company in an industry. However, because it is a new company, there is no previous history in terms of what they can be expected to return relative to the market. So it is impossible to calculate its equity beta. So what can you do?

You can look at a variety of other companies in the space, unlever all their betas to get asset betas and average them (as they should be theoretically the same, but will most likely differ slightly) and then relever it to the new company’s capital structure to approximate its expected equity beta. Armed with its equity beta, you can calculate its cost of equity using CAPM.

While this is how it would work in theory, there are some major problems with this model, the most obvious being:

How do you do “comps”? How do you define “a variety of companies in the space”, especially if few or none of the companies are exactly the same?
CAPM has its own issues which make it a less than perfect model
As a new company, they will probably not behave in the same manner as more mature companies in the space.

Here is an example:

There are four companies with different betas and leverage levels. By unlevering all the equity betas, you can have various approximations for what the asset beta should be. An average of all four gives you a decent approximation for the beta of the industry.

Now assume we have a new company in this space that will have a D/E of 50% at the same tax rate. We can use the leverage formula to calculate what the beta equity should be:

Equity Beta = Asset Beta * (1+(1-Tax)*D/E)

In this case, the equity beta would be approximately 1.3, which makes sense as it has a leverage between B and C and therefore should have an equity beta in between.

Excess Cash isn't always just from cash

2010-10-06T08:45:00.007-04:00

Putting together the last few posts (House analogy for EV, FCFF and NOWC and N[O]WC as a source of funds), let's look at an example of how they are all interrelated.

Target Company:
Total Assets = $100M
AR = $10M
Inventory = $15M
AP = $10M

Industry Average
Total Assets* = $100M
AR = $5M
Inventory = $10M
AP = $20M

* Total Assets for each company are deliberately the same to make percentage calculations convenient.

Let's also assume that looking only at the company's operations, you are planning on bringing the balance sheet accounts closer in line with industry average. Implicitly, you are improving the company's operations (reducing days receivable, days on hand and increasing days payables).

Therefore:
Change in AR = -5M (cash inflow)
Change in Inventory = -5M (cash inflow)
Change in AP = +10M (cash inflow)

Total cash inflow from Operating Working Capital = +5M +5M + 10M = +20M

This change in accounts reflects a type of excess which can be converted into "excess cash". These changes would be manifested in operations through:

Collecting on debts sooner, reducing credit terms
Selling out of inventory without replenishment (reducing inventory size and implicit days on hand)
Taking longer to pay our suppliers, using more supplier credit
Essentially, running "leaner"

This excess cash would be captured in a financial DCF model as a change in net operating working capital in the first year of operation and built into the company's EV calculation.

Enterprise Value - House Analogy with Excess Cash

2010-10-06T07:34:00.008-04:00

Another common question that comes up is related to enterprise value, particularly as it relates to excess cash. Recall that enterprise value is the value of the entire company and should be capital structure neutral.

EV = Equity + Debt - Excess Cash
or
EV = DCF Value + Excess Cash

The initial reaction is: "Wait, how can that be?" How is it that in one formula excess cash detracts from EV whereas in the other it increases? Does that make sense? In explaining, I find that a house analogy is helpful for understanding how to calculate EV.

Scenario 1:
Imagine Steve ownes a house worth $100k. Over the years, Steve has paid down his mortgage to $50k. Therefore, Steve's house's capital structure is $50k debt and $50k equity.

Dave is interested in buying Steve's house. For simplicity, let's say the house hasn't appreciated in value and is still worth $100k. Dave doesn't care what Steve's mortgage is, how much he's paid down etc. After all, that is Steve's capital structure. Dave is a new home buyer and is starting with a $20k downpayment and $80k mortgage.

The main point is that it doesn't matter who is buying the house (over simplified assumption), the house is worth $100k. It is an attempt to understand an unbiased (unlevered) way of looking at value of the company.

Scenario 2:

Let's assume a few changes:

The $100k price of the house includes $10k in cash which is sitting on the floor of a room
The house is being rented out as an investment property for $4k per year forever and the appropriate discount rate is 5%

Using the following formula:

EV = Equity + Debt - Cash = $100k - $10k = $90k

Does this make sense? Dave buys the house with $80k of debt, $20k of equity for a total price of $100k. However, immediately upon buying the house, Dave takes the $10k sitting on the floor and pays down his mortgage. Effectively, Dave has only paid $90k for the house.

Using the alternate formula (using a perpetuity formula for DCF):

EV = DCF Value + Excess Cash = $4,000 / 5% + $10k = $80k + $10k = $90k

That is to say, forgetting the cash, the house is worth $80k only from the income it generates. However, because the cash sitting on the floor is not integral to operating the house, it can be taken out of the house without affecting the income stream.

While it isn't an entire conicidence that the end numbers are the same (I've deliberately selected convenient numbers), it should hopefully demonstrate how excess cash in one formula decreases EV whereas in another in increases EV.

Free Cash Flow to Firm and Net Change in [OPERATING] Working Capital

2010-10-06T01:04:00.007-04:00

A few of my classmates have been asking me a very common question so I thought I would post the answer. Particularly because I think it is a fantastic question and is something I’ve wrestled with for sometime.

In Corporate Finance, Financial Management and Mergers & Acquisitions, one of the most important metrics of a company’s performance is it’s free cash flow. Or more specifically, it’s free cash flow to firm (aka. Unlevered free cash flow). This is the cash flow metric that is used to value the entire enterprise. It’s defined as:

FCFF = EBIT (1 – tax) + DA – NWC – Capex

Where:
EBIT is Earnings Before Interest and Tax (otherwise known as operating income)
DA is Depreciation and Amortization (which is actually a place holder for all non-cash expenses, but DA is the largest and most common one)
NWC – Change in net working capital (*NOTE* This is the tricky part that people are asking about)
Capex – Capital Expenditures

So while this formula is not new to most, what I want to focus on is NWC. If you have read my post on the difference between OPERATING working capital and working capital will know what I’m getting at.

First, before we even get to that, I want to emphasize a lesson taught in Anita McGahan’s first year strategy course relating to Dupont analysis (one of my favourite frameworks). Dupont analysis looks at Return on Equity and Anita made a fantastic point about how to look at the formula:

ROE = NI / Equity

ROE = (NI / A) * (A / E)

ROE = ROA * FLA

Where:
ROA is return on assets (Operational Strategy)
FLA is financial leverage (Financial Strategy)

In a discounted cash flow, a company’s value is calculated as it’s enterprise cash flows discounted at the appropriate enterprise cost of capital (it’s weighted average cost of capital).

In other words: In the summation formula, the numerator is operating (FCFF) and the denominator is financial (WACC).

This is another good way to think about the difference between OPERATING working capital (OWC) and working capital (WC) as I explained previously.

While the commonly accepted formula for FCFF is as explained above, anyone who has done a proper financial model is quick to learn that it isn’t change in net working capital which is important, but rather change in OPERATING net working capital (excluding financing items such as cash and short term debt).

FCFF = EBIT (1 – tax) + DA – NOWC - Capex

But the next logical question is what is the difference between something like short term debt (a quantifiable liability) and accounts payable (also a quantifiable liability which is equally a debt of sorts – a debt to a supplier). The answer? Interest.

The reason why something would be considered OPERATING working capital (or particularly an operating current liability) versus a normal working capital (or current liability) is that a financial current liability *bears interest* whereas an operating liability does not.

This raises the next interesting question: How do you treat pension liabilities? As you may recall, I mentioned previously how the CFA treat’s pensions as if they are interest bearing liabilities (or specifically, debts of the company owed to it’s workers which is expected to grow at the company’s cost of debt). This is a perfect example of a judgment call. Some of the top equity research analysts will consider pensions to be part of operating a business (not included in enterprise value as a financial consideration) whereas others will consider pensions to be a type of financing (don’t take my word for it, check out the research reports of companies with sizable pensions and see how different analysts treat different companies). Some will consider current pension obligations as debt (as it has to be financed to be paid out) whereas others will treat the entire long and short term obligation as debt.

Study Tour Applications - Latin America Study Tour Series

2010-10-05T18:17:00.001-04:00

Applications for study tour have been submitted for January tours and students are getting emails for interviews over the next period. It seems like there are a lot of keen students who are interested in participating and it looks like there will be some strong candidates representing Rotman in the Middle East and China study tours.

Anticipating the release of applications for the May international study tours for Latin America, I've cleaned up my Latin America Study Tour Series and posted a link in the navigation bar for your reading pleasure.

Unconventional Sources of Funds

2010-09-30T15:32:00.004-04:00

A topic I've noticed has appeared in a corporate finance as well as financial modeling cases. Whereas people often think of raising funds in traditional methods such as raising debt and equity, I don’t think people pay enough attention to potential changes in free cash flow, particularly change in net working capital.

For instance, in corporate finance, we were discussing the acquisition of a private company and what considerations should be taken into consideration when acquiring the company. Besides the obvious item’s we’d learned so far, it was also useful to see what would happen to the company if it’s operations were structure in a manner similar to its public counterparts. That is to say, express AR as a percentage of total assets (as well as all assets and liabilities) and look at the change in cash flow that results from the aggregate change in each account when bringing the private company to the industry average. The result can provide a considerable cash flow in or out of the company. While this principle can be generally applied, this is easy to understand using working capital as an example. This is because that unlike capex, change in net working capital can possibly supply cash flow into the company if it was previously poorly managed financially or if new management can improve the cash conversion cycle.

In our financial management case example, this principle was more pronounced as the history of a company’s operations for four years worth of balance sheet items was produced. Activity / operating ratios were heavily underperforming, particularly in prepaid expenses (compared against revenue as an appropriate base) as well as accounts payable (days payable).

While an “unconventional” method of financing, this was one of the lessons from Bombril on the Latin America study tour, where Gustavo Ramos, the CEO, a former Rotman Commerce undergrad and Columbia MBA, told us about how he turned the company around when it was in financial distress. One of the methods he used to “finance” the company was to stretch the cash conversion cycle: negotiating with suppliers to get more favourable terms, being more aggressive in collecting on accounts receivable, managing inventory (reducing days on hand) etc.

While strategies such as stretching the payables is considered to be a last resort for companies in “survival mode”, it can also be used to trim a type of operational fat and is directly related to the calculation of excess cash (and also excess working capital) as you structure your balance sheet accounts with optimal weightings.

Any non-income generating assets that can be sold for excess cash without affecting the underlying FCF can create additional value for the company. Clearly, this unlocks value in the company not captured in at DCF, but does not make the DCF any less sustainable (valid).

Rotman International Fair

2010-09-22T11:30:00.004-04:00

Yesterday was Rotman's International Fair in the Fleck Atrium. The Global Business Association (GBA) hosted tables with food from around the world and there were table set up with various international opportunities.

I was present at the international study tours table and was happy to answer questions from students about what the study tours were like, how the application process works, etc. I think that with the future growth and development plans of Rotman and the $200 million expansion project of the school, international programs will be at the forefront of further developing the Rotman brand. I believe these programs will be of paramount importance to attracting talented candidates to attend the school from different parts of the world.

It is my hope that students will be interested in applying for these once in a lifetime opportunities to extend their learning beyond the classroom (such as in the Middle East study tour and our trip to the Central Bank of the UAE and asking them about their policies) or how our visit to Embraer on the Latin America tour was directly related to our Global Managerial Perspectives (GMP) final exam of an aircraft manufacturer outsourcing parts and its exposure to foreign currencies etc.

Pop Quiz

2010-09-16T09:01:00.002-04:00

What is the value of a zero coupon bond with no maturity?

Back in the Mix

2010-09-14T23:50:00.000-04:00

Today marked my first official day back at school with my Corporate Finance class. I've essentially sorted out what project groups I'll be working on this term and have the opportunity to work with people I haven't worked with before (all with reputations for being smart and hardworking). It also occurs to me that there is also a notable bias towards JD/MBA teammates.

The school is abuzz with info sessions and recruiting events every day it seems as my classmates are constantly appearing in business formal wear and putting their best foot forward for potential employeers. People are taking the opportunity to really investigate what career they want to build and what direction they want to take.

There are also first year students who are now in the same place we were last year and some of my classmates have admitted that it is a bit "different" to suddenly be the senior students giving advice on the MBA program to a group of bright motivated students.

2nd Year Case Comp - My Turn

2010-09-13T21:47:00.006-04:00

Last year, I went to the 2nd Year Management Consulting Association (MCA) Case Comp as an observer to see the upper year students duke it out. Just like last year, there were a few first year students who came to observe. This year, I put together a team to give it a try. While we didn't place, the experience was well worthwhile. It certainly served as a good primer to get back into "the right frame of mind" for school.

I'm incredibly impressed with the quality of the presentations. One of my buddies came out with a truly unique solution to the problem presented and had an equally incredibly pitch to sell the idea.

One interesting lesson was why companies focus on top line revenue at the expense of bottom line income. While a short term focused company will need to produce results in the form of profits, a firm with a more long term outlook will often focus on top line revenue as a metric reflecting product and volume growth (with operational margins improving over time and producing future profits).

The first place team was a group of part time students, and I'm starting to notice a trend when it comes to part time students and their performance in case comps.

Orientation Camp

2010-09-09T16:49:00.004-04:00

Yesterday marked the end of Orientation Camp for the incoming students. Unfortunately, the weather was not ideal, but that didn't dampen their spirits or enthusiasm. During our costume parties, I was glad to see several group costumes as well as some well thought out and executed individual costumes.

Roger Martin also gave a good talk on what makes Rotman different and how integrative thinking is essential from creating good MBA graduates who have something extra. He explained how he envisioned for us to become good users and creators of models and that this will help us in our future careers.

The incoming class was eager and very inquisitive into the nature of the MBA program. They took advantage of the team activities to work with each other and get to know each other before school started. I think we have a great incoming class and I’m looking forward to watching their development over the school year.

It was very obvious from beginning to end how much work the orientation committee had put into organizing the event by the quality of the opportunities for students to interact and the relationships built at this formative stage of the MBA program.

Negotiations

2010-09-02T09:00:00.006-04:00

Classes have started a bit early for me as I've started taking negotiations this week (I had repeatedly missed this class for study tours). I've been taking this class since Sunday with the incoming Morning MBA class (apparently this is their first class that they take with FIT).

It's a fantastic class, showing you the mechanics of negotiation with the opportunity to practice your skills with your fellow classmates. A large component is experiential so I don't that it is easy to transpose the nuances onto a blog post. However, I have been told (and can understand why) this class is popular with students.

Most people would probably initially think that a negotiations course will help people "get a bigger slice", but that is too narrow a perspective. It focuses on tactics and strategies for how to enlarge the pie, how to ensure that the counter party feels like they have been dealt with fairly (even deals in which you concede a great deal of value is no guarantee that your counterparty will be entirely happy with the deal and can affect your relationship and future ability to negotiate).

London Business School - Electives

2010-08-21T23:27:00.005-04:00

So I heard back a few weeks ago from London Business School about all the course electives I applied for and I'm happy to say that I got them all. This means that the course I put at the top of my list will also be the last class I end my MBA program on: Service Management Field Trip (aka LBS Greek Study Tour). I've read a few great reviews of this course from other blogs (as well as for the other courses I've choosen) and I'm very happy with the results.

I've just finished my last day at Scotia on Friday and I'm catching up with friends and family before starting my negotiations course in a week's time (you know, that course I kept missing because I kept going on study tours?) I'm taking it with the incoming Morning MBA class so it will be fun to meet them.

Orientation camp is the following week and that looks to be good times. The costume theme this year is super heros and I think I have an awesome idea. I might post a pic after camp is over.

I've got a lot of stuff I need to catch up on, but will start picking up regular posting again soon enough.

Flight of Fancy: What If...? A Market for Bid Points

2010-08-02T04:12:00.006-04:00

One common theme I've heard is that MBA's are often upset when they don't get all the elective courses that they want. While I certainly can't complain, it brings up an interesting question: "What if someone like me was able to sell their bid points? What would I get for them? And how would you value them?"

For example, my course choices weren’t very restrictive, I got 500 points to bid on four courses, most of which I could have gotten with a zero bid. Whereas, Mr(s). Ambitious was trying to take TMP and Value Investing while going on Exchange (physically impossible, Value Investing is a year long course and Exchange means you are physically gone). If there existed a mechanism (and therefore a market) for me to transfer my points for a price, what would I get for them? What should they be worth? Clearly, there is currently some "market inefficiency" as we are both unsatisfied: Mr(s). Ambitious because they didn't get all the courses they wanted [net deficiency] and me because I didn't realize the full value of my bid points because I had more than I could use - [net surplus].

Well let’s make some assumptions:

Rotman tuition is C$35k per year (let’s not include first year as it’s common, or you can adjust the value of points accordingly if you feel second year courses are more / less important)
You take 10 elective courses in your second year
You are given 1000 points with which to bid

A “book value” of the points would simply be C$35k / 1000 points or about $35 per point.

But keep in mind that when something is inherently useful, especially in a scenario where a few points margin can mean the difference between getting the course you really want versus having to settle for a less popular course, there can potentially be bidding wars from “oversubscription” (points trade at a multiple above their book value) especially if they were in limited supply.

While people are paying C$70+k to go to school, for a marginal $35 x 100 points (a rough approximation of the average points allocated per student / course) or $3500 you can get any course you want (including the highly coveted TMP and Value Investing – which includes a trip to visit Warren Buffet – one of the reasons why this course is so wildly popular).

If you could some how do it, you could see how much additional probability you have of getting into the classes you wanted and put a dollar value on how badly you wanted to be in that class (regression analysis), you can determine a price you’d be willing to pay to attend that class. For example: Would there be a correlation between the number of points you consumed to get into classes of your choice against your overall earning power once out of university (thinking along the lines of DCF to value bid points like common shares).

And also imagine if this market had a “market maker”. For example, the PSO will (create and) sell you points for a certain value (either regulated and pre-determined or floating with the market). Students could liquidate their points at market value and get money back or buy points of the market to be more competitive for course selection and the school could potentially get revenue from selling points.

And since you have a market with underlying assets, imagine if you created financial instruments for those assets (shorts, puts, and calls for bid points, futures).

And imagine if other schools had market systems (I’m told that bidding systems are not uncommon at other MBA schools), you could trade between these. Or even other programs!

Of course, these points would inherently have an “expiry” as to their value (you wouldn’t want to be holding (take delivery of) 5000 MIT Engineering points if you were going to Stanford Law School).

There are some interesting implications. For instance, a new ranking system for schools where the relative value of a course is determined by the market value (determined by students taking courses there) in real time with comparisons to year over year values. Example: Would an engineering calculus class go for more at Waterloo or Toronto? Could you couple this with flexibility between schools (accreditation programs) which allow students to take equivalent courses at other schools and what do you get?

It would be a more sophisticated and real-time version of tuition regulated by the market. Taken to the extreme, here is another idea: drop the original tuition completely and have students buy bid points for classes. And then what if you were able to connect this market to actual financial markets? An S&P Index of Undergraduate studies to benchmark the valuation of your individual class’ performance.

Another thought: If the value of courses in a particular faculty started to "overheat" would that be a leading indicator of oversupply of labour in a particular industry in 4 years time?

Bidding Strategy - The Mechanics

2010-07-29T04:48:00.015-04:00

So I've been lucky enough to receive all the classes I want in all the sections I want and it turns out that LBS doesn't use a "bidding" system per say (classes awarded based on listed "preference" - an ordinal system).

A few people were asking about how my bidding formula works and while it's hardly perfect, I figured I'd put up some of the details just for laughs (or a least as building blocks for someone who plans on taking this model to the next level). It uses only public information available to all students at the time of bidding.

In this model, each course bid is determined by three factors. The first is the inital base and most people will choose one of two initial bases: Last year's minimum bid or last year's median bid (depending on how competitive the class is).

After determining the appropriate bases for your five courses, the remaining points (“the Remainder”) can be divided amongst your courses to make your bids more competitive. But like all dilemmas in bidding, you want to assign just enough points so that you get the courses you want, but not so much that you jeopardize your chances of getting the other courses. So how do you do it?

I propose that the two major factors you should look at are what I call:

The Ballot factor (anticipated) (x% of the Remainder, or “X-Factor”)
The Historic factor (backward-looking) ([100% - x%] of the Remainder, or the “Y-Factor”)

Where x% is the weight of value of your Ballot factor versus your Historical factor (In other words: how much you believe your Ballot Factor represents real bidding behaviour versus historical).

Ballot Factor:

This factor accounts for the number of people who say they will take the course. A few notes:

People don’t always bid for the courses they ballot for
Use the numbers as guidance to see if the course is oversubscribed
Calculate the expected utilization capacity = total number of students balloting for any course in that section / total class capacity
Square the utilization capacity to create an “intensity factor”
Total all the factors and express each factor as a percentage of the total
Multiply the percentages by the X-Factor
The result is each individual courses’ Ballot Factor offset

Example:

2 classes have a capacity of 40 people each
You have 200 points allocated to Ballot Factor
20 people bid on Class A (fairly certain everyone who bids will get in… There is even a chance that a 0 point bid could win) has utilization 50% and Ballot “intensity factor” of .25
Class B has 60 bidders has utilization 150% (red flag: guarantee that not everyone will get in) and it’s “intensity factor” is 2.25.
Class A’s weight is .25/(.25+2.25) = 10%
Class B’s weight is 2.25 /(.25+2.25) = 90%
Class A’s Ballot factor offset is 10% * 200 points = 20 points (a non-zero bid with decent margin, you'll probably get in)
Class B’s Ballot factor offset is 90% * 200 points = 180 points (a strong bid, considering an average of 100)

This model tries to account for the fact that only very high bids will win the competative class, but you also don't want to low ball Class A incase a few stray bids appear from people who take the class last minute (obviously, the less people who originally bid on the class, the less you have to worry about dark horse bidders).

Note that it is 9x because at least 20 people are guaranteed to not get in the class. Classes that are oversubscribed will have intensity factors much higher than 1 with much heavier weights and undersubscribed much lower than 1 with much lower weights. This accounts for the premium on variation and intensity due to the number of bids in a competitive environment. Note that in this pure form, this is a best effort bidding mechanism with the scaling of points to consume all remaining points.

Historical Factor:

Another way to try to guess what the bidding will look like is to use the historical bidding as guidance for the variation of bids (were the bids tight or across a broad range?) One indicator of that is the minimum and median bid. If you make some HUGE assumptions, you can use these two points to create a normal curve with standard deviations. Since the mechanics of this are taught in stats in first quarter, I won’t bore my readers with a poor facsimile of Prof. Krass’ lecture.

Even if you don’t technically know the actual distribution of the curve, you can also use Chebyshev's inequality to position yourself within a certain percentile (also looking at the expected capacity utilization of the class based on your previous calculations). How? Here’s a hint (shown above): the bidding percentiles (% of students bidding that are not successful being admitted into the class) should be the same as the bid oversubscription capacity (again, huge assumptions) to provide the number of standard deviations. Combine this fact with the distance from the median to the minimum should provide a clue as to size of a standard deviation. Note that using this method, you may not (probably won't) have enough points to guarantee getting into the courses you want (unless like me, you probably have a surplus of points or are taking unpopular courses), but it is probably one of the best mechanical methods for balancing aggresive bidding with conserving points as well as building a view for what the bidding landscape looks like. In practical terms, at this point you can use a best effort model similar to the one shown above using the Y-Factor.

Also, I’ve deliberately left out methodology for mechanically scaling up courses based on your individual preferences (ie rating courses from 1 to 10 and incorporating that into your bidding strategy). Also, there are huge economic implications for bidding strategy considering that the involved parties do communicate with each other and affect the bidding levels of courses (ie Friends talk to each other about how they plan to bid). Signalling, game theory and strategy all come into play.

While not perfect, this model will give you some perspective into what a reasonable, very mechanically inclined bid would be. Admittedly, while I built this model, I did do some “emotional” adjustments to my bids (there was one course where I wanted to work with my friends on their team, so I wanted to be CERTAIN that I got the course). Like anything done on a computer, it’s just a tool.

Disclaimer: Like anything on this blog, this model does not guarantee any degree of success. This post is intended as a conversation / pensive reflection piece only. It is possible for you to use this model and not get ANY courses you want. For instance, it is physically impossible to get both Top Management Perspective AND Value Investing because both courses usually require exceptionally high bids. Note that by definition, there will be some people who don't get the courses they want. The more you want to be certain that you are in one course, the less certain that you will be in another (almost like the Heisenberg uncertainty principle). For better or worse, it is a zero-sum game.

Also, more importantly, I've been told that it's all a wash and at the end of the day, after the drop and add periods are over, most people get the courses they want anyways.

Round 1 Bidding Results

2010-06-04T23:47:00.006-04:00

Round 1 bidding has ended, and I got every course I wanted in all the sections I wanted. This should come as no huge surprise. I only had to take 4 courses, had a full 500 points and selected courses that weren't very popular / had low bid requirements. I also changed my bid. Rather than bid on Options, I decided to do Case Analysis and Presentation, an intensive course, with a team I think is mostly JD/MBAs who wanted a finance person on their team so I happily joined. I'm hoping that I can overload to take Options as well.

I've heard others were not so lucky. Quite a few people I know (a small non-scientific sample) did not get the courses they wanted or had to get slotted into a different section. I'm guessing this is because they bid for highly competitive courses which cost something absurd like Top Management Perspective (TMP, for 452 min to 548 median) or Value Investing (between 340 min and 360 median). This is in the context of being allocated an initial 100 points per course and with some courses going for 0.

Top Management Perspective is highly coveted (especially by would-be consultants) because there is a lot of meetings with CEOs and other top execs. Value investing is popular because of the annual trip to see Warren Buffet (Caution for anyone interested in this course: The trip could potentially be cancelled at anytime if you notice and read the fine print). Many people I know take Value Investing so that they can "get a photo with Warren that they can use in their promotional material when they start their own hedge funds".

On a modeling note, I'm pretty happy with how my bidding model worked. It predicted that certain courses would be over subscribed and calculated a premium factor for how to bid. For instance, Corp Fin, a normally non-competitive course (three sections of 33 people each), had a minimum bid of 50 (historically 0), meaning that some people were excluded. That means if you mis-read the historic bidding data and thought that you could save some points by bidding 0 (a common strategy for people saving points for TMP and Value Investing) you would have been left out in the cold. I'm thinking of posting my bidding formula later for calculating bid premiums for courses. I'd make some tweaks so that the formulas can be for more general use by students. It benefits everyone if we bid economically rationally.

Electives Bidding Close

2010-06-03T02:10:00.002-04:00

Today at 1 pm was the last chance to get your bids in for Round 1 of elective course bidding for next year. I put together a pretty neat spreadsheet (as I'm told MBA students do every year) to mathematically calculate what I should bid based on points available, course competitiveness and my desire to take the course. Results should be released later this week in advance of Round 2 of bidding which happens next week.

Also, I've selected my electives for LBS and have applied to take certain courses. There is a bit more to the process as they want you to have taken Capital Markets before you can select finance courses, but I'll have taken that by the time I get there. Read a few blogs on students going to LBS on exchange from different US schools and their experiences. I must admit, it has shaped my course selection.

Bidding for Electives Begins Today

2010-05-27T02:30:00.004-04:00

Bidding for elective courses in second year began today. I'm happy to report that I still have 500 points to bid (the rumor that I lost points for study tours is apparently untrue). However, I only have to take 4 courses this term (maximum and minimum). I'm trying to bundle them together all on Tuesday, Wednesday and Thursday so I can have a four day long weekend every week (and so far it seems possible).

I'm thinking of taking all the core IB courses in one go (so I can concentrate on electives at LBS) including: Corporate Finance, Financial Management, M&A and Options and Derivatives. Considering the sessions (date / time / profs) I want, I will have plenty of points (some courses requiring as few as 0 points).

I just need to confirm my selection with a few friends before placing my bid. Bidding ends one week after the open.

First Year Final Grades Released

2010-05-19T01:18:00.003-04:00

Grades from our Q4 classes were released today. While most students felt like this was the toughest batch of courses, I think that the grades panned out as they usually do (some up, some down, class wide aggregate average change of zero). I myself had flat grades (no significant change from previous).

Investment Banking and M&A - Scotia Capital

2010-05-17T00:09:00.003-04:00

I returned from the Latin America Study Tour very early this morning. After filling up on Chinese food at lunch and running a few errands throughout the day, I'm finally settled at my new place.

Tomorrow, I'll be starting as a Summer Associate, Investment Banking and M&A at Scotia Capital. I anticipate being very busy and will also not be putting up any posts until I return to school in late August (probably with a post from MBA Orientation Camp).

So far, the CFA / MBA journey has been an exceptionally rewarding one and I am really looking forward to what challenges await in the summer and the opportunities of the coming year.

PREVI

2010-05-16T11:29:00.002-04:00

[LAIST Tour Begins, Fazenda Tozan, Churrascaria – Nova Pampa, Port of Santos, Deloitte, Embraer, Natura, Gol de Letra, Bom Bril, Agencia Click, Nextel Institute, May 6, Rio, Rio Weekend, Petrobras, PREVI]

Previ is Latin America’s largest pension fund (34th in the world) and manages funds for Banco de Brasil employees. They have R$142 AuM where the 10 largest pension funds (including themselves) have less than R$300B and the entire industry is estimated at less than R$500B. They have the following allocations:

Fixed Income: 31% (max 100%)
Equities: 63% (max 70%)
Real Estate: 3% (max 8%)
Structured Investments: .54% (max 20%)
Investments Abroad: 0% (max 10%)
Loans to participants: 3% (max 15%)

The interesting story here is that they currently have zero exposure abroad (or 100% domestic exposure). They only recently made a change such that they could invest a maximum of 10% of their assets in foreign countries and will probably be looking in the future to find good investment opportunities abroad.

They currently benchmark against the IPSA (indexed to inflation) and look for a +5.5% spread (usually ending up at a hurdle rate of 12.6%). They currently earn through the common 2/20 model, with a 2% management fee and a 20% performance fee for every dollar earned above the benchmark.

Being a pension fund, they prefer low leverage as there is plenty of volatility in the Brazilian markets. Their high (63%) exposure in equities is a result of their heavy investments in certain Brazilian companies and their lack of asset reallocation (doesn’t make sense at the moment for them to divest from large or controlling positions).

However, their corporate governance focuses on how they manage investment decisions to focus on dividends as a cash flow, investment rates of return and the liquidity of their positions. They also try to make investments in sectors which are a priority for developing Brazil’s industries in general including Structured Investments in Private Equity and Venture Capital as well as infrastructure such as the metro, roads, rail, sea ports and airports.

They even presented a case study on Vale. In 2001 Vale was in rough shape. The company needed a corporate reorganization as the financial performance was weak and less than expectations, they lacked strategic direction and transparency. In a move of shareholder activism Previ (similar to what OTPP did with Petro-Can last summer) shook up the corporate structure and took at 14.4% stake in the company.

Previ focused the restructuring of Vale on different strategic horizons. Horizon 1: lead in iron ore and expand capacity in pellets. Horizon 2: Global prominence in bauxite and alumina, growth though exploration, acquisition and joint venture and develop logistics networks. Horizon 3: Acquire non-ferrous businesses. Since these changes, Vale has traded at a spread over the IBovespa index, earning a return from 2001 of 412.02% beating the index’s performance of 54.91%.

This also brings me to the original point of my interest in the study tour. In the current economic market place, it becomes increasingly difficult to be insulated from the world economy and to be truly domestic. In the Vale example, while Previ doesn’t officially have investments in foreign companies, Vale does, having recently acquired Inco from Canada. Their commoditized products, namely iron ore and nickel, also trade on the international market. So while Previ doesn’t officially have foreign investments, they are not insensitive to the global macroeconomic conditions.

The example I’m always given is a company like IBM, where although they may be a US company, they have clients around the globe so they actually have exposure to international markets.

Petrobras

2010-05-16T11:27:00.002-04:00

Petrobras is one of the top oil producer, refiner and associated industries company in the world, headquartered in Rio de Janeiro. They are currently 55% owned by the government (representing 1/3 of the total equity of the company) with the government owning a golden share (similar to Embraer and Vale) which allows the government the first right of refusal on various governance issues. Looking at massive capitalization, Petrobras is considering issuing more of their stock which is currently trading at a PE of 10.5x with an industry benchmark of 10x.

However, with Petrobras in the midst of heavy capitalization which begs the question of whether or not they plan to maintain this government owned model if they decide to continue to raise capital in the public markets. Currently, they command 14.17B boe and their major costs are their appraisal costs in exploration and their production costs split between lifting costs and government costs. The current extraction price of oil is an attractive $24.74 USD with a $9.51 lifting cost and a $15.23 government cost.

Petrobras is currently seeking to drill for oil in more extreme depths than it is currently operating at looking at their Presalt projects (projects similar in nature to Canada’s oil sands in that they are looking at unique locations with which to extract oil). When asked if this will increase their lifting costs, they remarked that they initially expected costs to rise as much as 20%, but have since revised that number to be equal to or less than current costs as a result of the economies of scale through automation.

However, it is not without challenges. The new oil sites will be 300 km out from the coast line where the traditional helicopters used do not have enough range, requiring them to purchase new types of equipment. They will also require hubs as jump points to the new rigs to store inventory, food and maintenance equipment. There are also implications for transport of product back to shore.

There are also new changes expected in the regulatory model they use. Currently, they are using a concession model, but may possibly switch to a production sharing agreement where companies bid and allocate a percentage of the oil profit to the government. The strategy for some of these companies (example those in China) may have a strategic benefit to bid higher (as a strategic buyer versus a financial buyer) in order to gain access to the oil reserves (the story I had come to investigate, the effect of a resource race on international business relationships) producing a sort of vertical integration which would technically remove a double bottom line (an idea thwarted by the financial theory we learned in Finance II but revisited in Managerial Accounting). The current rules for bidding are that at least 30% of the profit must return back to the government, and the government can refuse bids which are not economically viable (allocating too much of the profit to the government and overbidding for the resource) and Petrobras continues to dictate what technology is used in extraction.

Another interesting relationship they have with China is through the Chinese Development Bank where they have procured a $10B loan, $3B of which is executed through a barter system of trading oil for products. However, apparently China’s new policies with trade throughout the world are stepping on a few toes as they are generally changing their strategy such that they don’t want products from the rest of the world, but are continuing to export to partners. However, a company like Brazil (and Canada) wouldn’t be interested in just exporting commodities without developing their own industries which causes some friction in the business relationship.

When asked why they don’t just acquire refineries as part of their strategy, they mentioned that it is really expensive to do, that complex regulations make it difficult and that retrofitting or upgrading their a rig to increase capacity is generally not financially viable.

They prefer to make an entry via a joint venture with partners to explore new reserves in different geographies. Once a discovery is made they also prefer not to be an operator in these locations.
Also, in some countries like Argentina, where the regulations are about to dictate the price of oil, the financial viability of projects in the region become unattractive (a very subtle and modern form of expropriation) and companies in that region are generally looking to divest operations in those markets as capital continues to flee Argentina.

With Brazil having a leading role in the development of bio fuel (Ethanol), Petrobras explained how they could create bio fuel efficiently from sugar cane with an Energy Out / Energy In ratio of 8.3, beating wheat at 1.2, corn at 1.3 to 1.8 and sugar beet at 1.9. They use their Petrobras Research Center, the largest in Latin America, to focus on three development goals: Expand limits (exploration), Enhance Product Mix (new product techniques) and Sustainability (CO2 production, H2O management and energy efficiency). One example of a project they are working on is 2nd generation bio fuels, where they use a special enzyme from biomass byproducts to create more ethanol.

[LAIST] A Weekend in Rio de Janeiro

2010-05-10T11:45:00.003-04:00

Saturday in Rio – Christ the Redeemer

We had planned to visit Sugar Loaf Mountain, but the conditions were not appropriate for a visit so we ended up going to Christ the Redeemer. We also picked up some supplies for the soccer match the next day. We also got a chance to check out the local night life.

Flamengo versus Sao Paulo

Our guide took us to a soccer match at Maracana between Flamengo (the soccer club with the second largest fan base, second only to Manchester United). As we were walking to the Metro station, already half a street away from our hotel and decked out in Flamengo gear, we were being heckled by a Sao Paulo fan.

We were certainly sitting in the right section as there was almost as much entertainment behind us as there was on the field. The fans are passionate, cheering through the entire game non-stop and waving their massive flags. While we didn’t understand the Portuguese cheers, we shouted similar phonetic sounds while mimicking the same motions.

While the game ended in a 1:1 tie, it was certainly an experience to be there when the team scored a goal (as well as each time there was a “controversial” call). I can understand why this experience and culture would be described as a “religion” by our guide.

[LAIST] May 7th Visits – Rio de Janeiro

2010-05-10T11:42:00.001-04:00

[LAIST Tour Begins, Fazenda Tozan, Churrascaria – Nova Pampa, Port of Santos, Deloitte, Embraer, Natura, Gol de Letra, Bom Bril, Agencia Click, Nextel Institute, May 6, Rio, Rio Weekend, Petrobras, PREVI]

Upon arriving at Rio late at night, we made a quick reconnasance of the area before calling it a night. The next morning, we were up and ready to go to our next set of meetings.

TV Globo

TV Globo is the largest group of media and entertainment companies in Latin America. They are focused on TV and entertainment, print and media and radio; telecommunications and distribution.
Because of their influence on the Brazilian society, they have been playing a unique role as educator. Although Brazil has language unity, there is a great deal of cultural diversity which plays a unique challenge to media broadcasters. In a growing economy, Brazil’s newspaper readership has been growing rather than falling, primarily because of the growing C class (lower middle class).
Brazil is divided into a class system (not well explained if it is a formal or informal class system – need to look into this more) where there are A1, A2, B1, B2, C, D and E rankings.

TV Globo mentioned that infrastructure remains the biggest challenge for Brazil, not just in terms of roads and rail, but rather in education in the form of schools and labs for students to learn.
TV Globo uses their Tela Nouvella’s (sophisticated versions of soap opera’s) to address social change. They often hire sociologists to address social issues that are currently on the minds of Brazilians addressing topics such as racism and . They treat this service as a charitable non-cash forgone revenue expense.

Vale

The next presentation was at Vale (recent acquirer of Inco) the largest producer and has the most reserves of iron ore in the world (2nd largest resource producer in the world). Their business is 35% based in iron ore, demonstrates stable demand and has recently successfully moved from a yearly pricing model to a quarterly pricing model.

We had a talk from a political analyst two was describing the broad range of international investments of Vale in different parts of the world including Asia Pacific, South America and Africa.
In the crisis period, 38% of their revenue was from China, their number one client, who was previously only accounting for 17.4% of their revenue previously (number one position in the past also).

The cycle for mining is usually 3 to 8 years for exploration followed by licensing and 4 to 5 years to open and build the mine and infrastructure required to develop the mine. Their required IRR is 12+% and they have 12 golden shares held by the government (similar to Embraer).
One of their largest challenges is relocating indigenous people, developing infrastructure and developing communities at mine sites. Once a mine’s resources are deleted, there is a large outflow of business which can potentially decimate at geography, so Vale is careful to build a legacy plan and invest in the community remain stable after their exit including schools and diversified industry.

Brookfield Brazil

Next we had a talk from the CEO of Brookfield Brazil, an asset management company with $100B USD AuM and $22B invested capital. They talked about the macro factors affecting investment in Brazil including the allocation of 4% of Brazilian GDP towards social development, allocating resource surpluses towards financial deficits versus social deficits and the challenges of moving from an “artificially fixed exchange rate” to a floating rate.

He also mentioned the rebirth of the consumer class in Brazil, or the so called D and E class to the C class and how Brookfield was capitalizing on commercial real estate development. Their strategy is to invest in tangible assets where there are high barriers to entry, predictable long term cash flows and they prefer to be operators rather than passive investors.

Their IRR is 12% and they tend to focus on quality of investments rather than increased marginal returns. Their strategy allows their mall properties to command the same sales per square foot as comparable US malls. The mall model is different in Brazil than what we are used to in NA. Rather than have high city density where consumers drive to malls or super centers in sub-urban areas, Brazil malls tend to be in the city, with high density, vertical and paid parking (a surprisingly large 12-15% of mall revenue) and demonstrate less dependency on large anchor stores (such as Walmart or Sears). Consumption growth is currently well above the GDP which is having a large effect on the financial and economic strategy of the country.

With their high 16.7% Tier 1 capital ratio in Brazil allowed many Brazilian asset management firms like Brookfield take advantage of depressed prices in the market as a result of the recent financial crisis. They prefer to avoid higher leverage, look for quality of earnings and a high level of liquidity which allowed them to take advantage of special situations.

With the acquisition of many new properties, they have boosted their CAGR to a whooping +119% (keep in mind that this is a result of massive acquisitions and actually investing more of their AuM). When investing, the look for different partners including: Institutional, sovereign, pension, endowment and family funds. We were told they were partnering with 2 Canadian Pension funds, 1 Asian sovereign fund and 2 European family offices. You can probably guess who the Canadian and Asian sovereign funds are.

They prefer partners who have the same market views and investing profiles: long term, stable predictable growth and high cash positions and liquidity (all attractive makings of a proper pension fund investment).

They also have a unique array of investments, including agriculture. They raise cattle as one of their primary investments and follow their operator strategy. What does this mean? They may be one of the few companies where cowboys who work in a company which complies with Sarb-Ox and is audited by Deloitte. The work environment creates a unique culture.

LAIST - May 6th Company Visits

2010-05-10T07:19:00.004-04:00

Itau Unibanco

On Thursday, we had an opportunity to visit Itau Unibanco, the 10th largest bank in the world with $98 USD market capitalization, as result of their recent merger between Banco Itau and Unibanco in 2008. With 95% of their assets in Brazil, they enjoy an ROE of 22.3%, CAGR of 21.7% and 33.5% market share of the Brazil market. Itau Unibanco described their unique role in the Brazilian economy (their success being highly correlated to the success of Brazil using such measures as the GDP).

Brazil’s financial success has been attributed to their stability in the financial crisis. They have the highest reserve requirements in the world, something that in good times causes you to have a huge cash drag on your capital investment performance but in bad times allows you to take advantage of special situations. Yet, Brazil has a long way to go. We’ve repeatedly heard the story that Brazil’s infrastructure is in need of significant investment, as when the GDP accelerates beyond 5 – 6%, the country experiences inflationary pressure. With the upcoming election, it appears that regardless of who wins, the broad based economic policies will be the same (similar to the UK’s hung government elections currently underway).

Brazil is currently in the process of extending credit to its citizens and managing the introduction of delinquency and risk modeling to correctly price the value of different types of credit (credit cards, mortgages etc) to different people. They are making a particular effort to “get it right” using a variety of measures such as loan value / asset value and credit ratings. Itau Unibanco’s strategy is to correctly price mortgages in the market using a credit score system and charge a spread over loans made as a ratio of asset value.

Copagaz

Next was Copagaz, a Zahran group company, very similar to PKM, CPSB where I worked in Malaysia as well as SS. Lootah in the UAE in the MEIST, as a family owned private holding company which consists of a portfolio of a variety of other subsidiaries. Copagaz is primarily a propane distribution company which started when the owner and founder, Ueze Zahran. He tells the story of how he was first interested in propane gas when his mother, living in Mato Grosso, met her sister in Sao Paulo and saw the blue flame of propane gas, a much improved method of cooking over the traditional wood fire. In amazement, Ueze’s mother asked him to go to Sao Paulo and return with a stove and four propane tanks.

Seeing the opportunity and need for a propane company, Ueze created Copagaz, what started as a small gas distributor and has evolved into the Zahran Group of companies including Globo Network programming in TV, FM radio and other media, and agriculture including soybeans, Arabian horses and Simmental and Nelore cattle.

Ueze was asked about the growth of his company and remarked that infrastructure was the largest of his costs and one of his biggest issues (a story which has become a common theme). Because of the nature of liquid petroleum gas (LPG) delivery, his has high costs in replacement on the wear and tear on the actual propane tanks themselves.

Copagaz also built schools to promote reading. They have literary classes available after school and for those who decide to continue with schooling, Copagaz will support up to 70% of the tuition and has had their first graduate of this program in 2000.

After a uniquely interesting meeting, Ueze asked to treat us to dinner at Fogo de Chao (“Fire of the ground”), the best Brazilian steak house in town where we had our fill of meat and drink and dessert. Apparently, in the Brazilian culture, it is more important to have a heavy lunch than dinner as every where we’ve been so far has served hot meals for lunch with sandwiches and other cold fair surprisingly difficult to procure.

Ambev

Our last visit of the day was to Ambev maker of beverages. While we in Canada are more familiar with Ambev’s alcoholic line of beverages (after the acquisition of Labatt and Alexander Keith’s), in Brazil, they have their own line of beers as well as a complementary array of isotonic (sports drinks) and soft drinks.

Ambev currently enjoys an EBITDA margin in the 48.8% range and has demonstrated steady EBITDA growth (their mission is to double EBITDA every 5 years which they have been successful at for at least the past ten years). Their strategy is to compete for market share where their share is low, but to grow the market if they have over 70%.

Their Strategic pillars are: Top line revenue growth, manage their brand equity, pursue excellence, cost efficiency, financial discipline, all built on the foundation of their people. They are also religious in improving their processes, trying hard to learn manufacturing processes like Toyota's lean manufacturing and others such as green and black belts in six sigma.

While many companies preach a culture of success, we were shown how living this philosophy has consequences. For example, their philosophy of “dream big” is accompanied by the responsibility that their sales targets must never be smaller than the previous year. They also have a employee review process that is similarly modeled after GE’s style meritocracy, where growth can be accelerated through achievements, but being laid off can be guaranteed just as quickly though failure.

We then headed over to the airport where we flew to Rio de Janeiro.

Nextel Institute

2010-05-05T18:28:00.005-04:00

The Nextel Institute is a NGO which provides additional training for at risk and vulnerable youth aged 16 to 24. They are funded by Nextel and work in partnerships with companies like Agencia Click.

They have had explosive growth, placing 70% of their 124 participants in 2008 and 60% of 390 in 2009, more than doubling their success rate.

This tremendous growth has caused this foundation to look at developing new locations and partnering with additional companies to absorb the additional youth looking for employment.

Agencia Click

2010-05-05T18:28:00.004-04:00

Much of this visit was confidential (as is the nature of high tech I suppose), but there were some interesting ideas which they discussed with us which were fairly clever.

The idea that a product or service needs to be irresistible rather than big, that online media has changed our perception of advertising from a 360 view around us to a 365 day world requiring open, continuous and on demand and that creating time was the new strategy rather than buying time.

Bom Bril

2010-05-05T18:26:00.004-04:00

Gustavo Ramos, former UofT Engineering student (class of ’95) and Columbia MBA (’01) and CEO of Bom Bril, gave us a presentation on his involvement in the company since arriving in 2006 and finding Bom Bril, a leading manufacturer of consumer products, on the verge of bankruptcy and in receivership with the government. Bom Bril had delayed payables such as wages to employees and had not paid any taxes. The largest liability was to the government in the form of unpaid tax.

Having never worked in a distressed company before, Gustavo smiles as he recalls how he approached the problem: His professor at Columbia had said that gold rule of finance: “Cash is king”.

With his work cut out for him, Gustavo started to fix the problems, first by negotiating a 15 year payment schedule to alleviate the government debt. He proceeded to adjust prices and margins on products, renegotiate with suppliers (focusing on the value of Bom Bril to the industry as an ongoing concern) to reduce working capital and cutting marketing spending.

Gustavo generally tried to insulate the end consumer from the financial problems at Bom Bril as well as the lower level employees (no layoffs). When asked if Bom Bril was ever a takeover target, he mentioned the 2001 attempt by Clorox to take over Bom Bril which fell through when Clorox balked at the liabilities on their balance sheet at the due diligence stage.

In my opinion, I think this was a very bold strategy that worked for Bom Bril and reminds me of our Coca Cola case that we had with Anita McGahan in Strategy I, when we were talking about the intangible value of Coca Cola and why that couldn’t be duplicated by Sir Richard Branson in his attempt to introduce Virgin Cola. Although Virgin Cola’s annual spend on marketing was equal to Coca Cola, Coke had built up a tremendous amount of brand equity over its history dating back to world wars and that wasn’t going to be reproduced over night. In the same way, I expect that Bom Bril’s strong brand equity allowed them to coast briefly as Gustavo put their ship back in order. Either way, it was a bold move which has been attributed to the companies turn around.

With the return of Bom Bril to profitable status (with 40% growth and a 17% EBITDA margin), Gustavo laid out his plans for the future of Bom Bril:

Remodel product lines – expand, change formulas, improve the packaging
Launch new product categories – clothing care, silver and brass polish with all new products branded with Bom Bril
Heavily reinvest in marketing to make up for lost time – Launching new brands and supporting old ones. Having a spend that focuses on the Point of Sale rather than just mass marketing. Marketing is budgeted at 5% of sales

He also explained how Brazil’s market for Consumer Product Goods (CPGs) are different than in Canada. Where we are familiar with large distributors and retailers (such as Tesco, Carrefour, Loblaws, Walmart, etc. which only account for 15% of Brazil’s CPG market) where we drive our cars to the store, Brazilians walk to the local mom and pop shop and distributors have a much more difficult time managing the various touch points.

He acknowledges the 3 most important factors for CPG: Brand equity, distribution channels and low cost / scale.

Recently, Bom Bril’s new found success has increased its appetite for acquisitions, having purchased Lysoform, a European disinfection product to add to its repertoire of products. Bom Bril continues to expand, looking for acquisitions or partners who are leaders in niche categories to fill the blanks in their portfolio.

In understanding Bom Bril’s business, we learned about the exclusive nature of relationships with Bom Bril’s distribution network and the economies of scale achieved with non-competitive products where the high costs of the fragmented distribution network could be shared with partners like Kraft.

Their COGS are generally (80 to 85%) composed of raw material costs and they are therefore sensitive to changes in the price of iron ore, the primary ingredient of their flagship “Bom Bril” product, an inexpensive steel wool whose name is almost generisized in the same way as Kleenex and Band-Aid.

Bom Bril is also the first company to release a line of eco products in Brazil: “Ecobril”. Their ideology has been successful on the premise that performance and cost (retail price) are the primary drivers of success in this CPG space, and ecologically friendly is a tertiary concern. This caps their price of their products at 10 to 20% MAX above the price of their normal products. However, by balancing these pillars, they have had success beyond other entrants into the eco space. They also focus on the 4 R’s, which are the 3 R’s we are used to plus “Respect for Biodiversity” which acknowledges their use of natural raw materials versus synthetic and no animal testing.

Another interesting story about Bom Bril’s EcoBril line is that some of the products have the options of buying refills. The irony is at this stage, the cost to manufacture the refill is almost the same as the original packed bottle (due to low economies of scale), however, the nature of the business is to charge 30% less. With increased economies of scale, Bom Bril expects to bring this price down making eco refills more attractive as a product line to Bom Bril in the long run.

Bom Bril’s history is quite fascinating and integrated into the social fabric of Brazil as a staple CPG company and product. Mr. Bom Bril, played by Carlos Moreano, is a local celebrity how has the accolade of being the longest running ad campaign series as noted in the 1995 Guiness Book of World Records.The visit to Bom Bril concluded with a walk through their factory (no photos permitted), but it was interesting to see the unique history (and plans for the future) of the company.

Gol de Letra

2010-05-05T18:25:00.005-04:00

[Delayed from yesterday, photos and video forth coming]

The Gol de Letra Foundation is a non-for-profit organization founded by Rai Souza Vieira de Oliveira, former Captain of the National Brazilian football team, and Lenardo Nascimento de Araujo, midfielder for Brazil and current manager of the Italian A.C. Milan FC.

The project reaches 1200 youth and has been running for 10 years in Sao Paulo and Rio de Janeiro and has received recognition from international organizations such as UNESCO in 2001 as the world model for helping underprivileged children. Their core values are dignity, fraternity, perseverance, solidarity.

They find the most vulnerable children in the community and provide a place for them to play and learn. Typical school programs only last half a day, with school access not nearly as prevalent as in countries such as Canada, so programs such as Gol de Letra fill the gap to provide opportunities not necessarily available otherwise.

Their programs promote literacy, physical education, music and social interaction with peers. We were treated to an impromptu Brazilian musical performance by some of the children.

Certainly one of our more fun visits, we also participated in a game of “chain tag” running around with the kids. It was absolutely moving when the adorable little kids were giving us hugs goodbye.

Natura

2010-05-04T18:36:00.003-04:00

[LAIST Tour Begins, Fazenda Tozan, Churrascaria – Nova Pampa, Port of Santos, Deloitte, Embraer, Natura, Gol de Letra, Bom Bril, Agencia Click, Nextel Institute, May 6, Rio, Rio Weekend, Petrobras, PREVI]

Natura has earned its place as the leading cosmetic company in Brazil through its enlightened management practices. Their philosophy emphasizes the idea of harmony, and the use of cosmetics as a moment of self-reflection. Their factory headquarters could easily be mistaken for a California high tech company in Silicon Valley, with its campus style feel. They have exceptional benefits for their employees, living their ideals of respect and the triple bottom line: Monetary, social and environmental benefits. There is an onsite day care, laundry, restaurant, movie rentals, internet and other amenities for the one million employees (80% of whom are women). Shifts begin and end with a 10 minute exercise routine each day.

Natura aims to be carbon neutral, and has a variety of unique initiatives: they were the first cosmetics company to do a “true beauty” campaign using employees and customers in ads rather than models, a strategy later adopted by Dove in North America. They were the first to use organic alcohol in their perfumes. They also aim to be carbon neutral and label their products with water consumption, % certified raw resource usage and even brail lettering, practices that are well ahead of their time in the cosmetics market place.

Natura is a major player in developing the industry. They have the largest perfume plant in Brazil and hire perfumists (which they say are less common than astronauts) who require 10 years of training in order to create new perfume formulas.

In focusing on relationships, their sales model is also fairly unique. The use a direct sales model and word of mouth that would be similar to a highly structured multi-level marketing model with some key differentiators. Rather than force consultants to build tiers underneath them to make money (a model which often collapses in on itself), consultants focus on building relationships with clients and can occasionally introduce new potential consultants into Natura. After bringing in 10 other members, the consultant can potentially become an orientation consultant effectively giving themselves an unbiased merit based promotion. However, each consultant must being to make sales within the first three months or risk losing their consultant status.

90% of their consultants are women and range in age from 18 to 85. The only requirement for employment is to have no outstanding bank debt – There is no educational limitation. The most important quality to work at Natura is belief in the philosophy (Natura is known to do job postings withholding their name and posting only their values).

However, don’t be fooled into thinking that this socially responsible and relationship based mindset makes them any less competitive. Quite the opposite, they enjoy a 40% EBITDA margin and an exceptionally well run production facility. They structure their manufacturing teams in the same model as Toyota, using a team based around production lines in a Total Productive Manufacturing (TPM) system incorporating job rotations. Their manufacturing facility is highly (almost completely) automated, and their inventory management system requires a shockingly low amount of space (rather than have forklifts and operators, the inventory is housed in extremely narrow shelving units managed by an entirely automated system, saving a great deal of real estate). RFID technology is also used to ensure that complex orders are filled to exact specifications as required by their consultants.

Natura is currently focusing on Latin American markets employing different business models for different locations (beginning to employ a bricks-and-mortar store front concept for other geographies) and it’s only non-Latin America presence is in France, but they seem to have their sights set on some of the larger cosmetics markets in the world.

Embraer

2010-05-04T18:34:00.003-04:00

After World War II, Brazil decided to implement a strategic national aircraft manufacturing project. In 1969, the Empresa Brasileria de Aeronautica (Embraer) was established for the manufacturing of two of Brazil’s first prototypes. In 1994, Embraer was privatized merging its technological and industrial capabilities with an entrepreneurial drive. Today, Embraer is the largest manufacturing exporter (3rd or 4th largest exporter in general) in Brazil.

They focus on their 5 pillars – High tech, qualified people, global presence, cash intensiveness and flexibility. Because of the exceptionally technological nature of aircraft design and manufacturing, they hire a large number of Ph.D (2%) and post-graduates (4%) in various technical fields. With the PPP and associated salaries, they tend to hire engineers locally, many coming from Brazilian universities such as ITA (founded in 1950, which has a graduating class of between 120 to 150 students per year going into various fields). Embraer’s engineers are coveted around the world for their proficiency and technical skills.

They also support the local community through education, opening a high school in 2002 with a technical and engineering focus which now boasts being the top school in Sao Paulo (competing with local private schools) with 80% of their students excelling in the college entrance exams (100% matriculation rate).

Embraer has a variety of different aircraft, the most unique being the Ipanema, the first certified and serialized 100% biofuel aircraft (apparently used for crop dusting). The development for their commercial aircraft is usually between 4 to 5 years with a 10 year product life cycle and their Embraer 170 to 195 series (70 to 122 seaters for midsize commercial use) share 80% common parts which allows airlines to maintain smaller inventories of spare parts and reduce the training required (the 170 and 175 pair and the 190 and 195 pair share wings and engines between pairs, 95% commonality, and the series has otherwise identical fuselages which are scaled for size).

Since Privatization Embraer has been trading on the NYSE (53%) and Bovespa (47%), but the government still holds a “golden share” which restricts some of Embraer’s actions (the 6 positions: No acquisition by foreign investors, approval of change in logo, and 4 rules relating to defense contracts).

When asked what was their biggest input cost exposure, our host explained the idea of currency fluctuation in the value of the Brazilian Real versus international currencies (which reminded all the first years of our recent GMP exam – a case study of the international manufacture and sales of airplanes).

They also identified to us the mechanics of their revenue streams:

Example. Assume a client (a major commercial airline) is thinking about to buying around 14 aircraft. They might make a firm order for 10 planes, but retain options to buy 8 more (using the same financial terms) if they decide they want more capacity. Embraer recognizes that historically, 50% of all options materialize (become orders) and has currently delivered 3 of the planes to the client.

What mechanics are involved in understanding their sales as well as their operations?

Maximum Sales = Firm Order + Options = 10 + 8 = 18

Firm Backlog = Firm Order – Deliveries = 10 – 3 = 7

Expected Sales = Firm Order + Options * P(Option materializes) = 10 + 8 * 50% = 14

Expected backlog = Expected Sales – Deliveries = 14 – 3 = 11

There are implications for managing and maintaining a consistent backlog (guaranteed revenue streams). Also aircraft sales are considered to be a lagging indicator of the economy.

Ethanol Fuel – Is Sustainable Fuel Socially Responsible?

2010-05-03T17:36:00.002-04:00

In our Business Ethics class, I had done a presentation on the Ethics of Ethanol Fuel and now that I am in Brazil, the topic of ethanol fuel and its relationship to sugar cane and other staple food commodities has been emphasized. And even if global trade increases and creates wealth it does not make any guarantees with regards to how that wealth is distributed as explained by our GMP Prof. Blum.

I proposed this question: “Is it ethical for rich countries to drive cars if it causes poor countries to starve?”

This problem was exacerbated in the World Food crisis in 2007 and 2008, when oil prices hit all time highs and the arbitrage relationship between oil and food was exploited.

Here is the relationship:

The US and Brazil are the largest producers (89%) of ethanol fuel using corn and sugar cane (respectively).
When oil prices increase, people have a tendency to switch to ethanol based fuels.
When the demand for ethanol increases (as a substitute) the demand on the inputs for ethanol (corn, sugar cane, potatoes) also increases.
There are real arbitrage opportunities by hedgers, speculators and even farmers as they shift the use of arable land to produce more valuable crops. However, even with arbitrage there are limits as arable land is limited (to create more arable land, there is often deforestation which creates its own sustainability issues).
Also poor countries have a much higher sensitivity to fluctuations in the price of raw commodities whereas rich countries are insulated from food costs because they only represent a small percentage of the final costs (including value added costs such as manufacturing, distribution and retail costs). It’s the difference between eating a bowl of rice versus a bowl of Rice Krispies.

The consultants at Deloitte confirmed this relationship in very concrete terms using the Brazilian gas pumps as an example (where prices for ethanol based fuel versus gasoline are explicitly posted in the same way gas prices are at the pump). Currently, the cost of Ethanol fuel is 50% the price of gasoline (although it only provides 70% of the performance). However, in the “off season” when sugar cane is more expensive, it can even reach a price of 80% of gasoline (which is clearly not as cost effective). There is a direct relationship between the price of sugar cane and the price of ethanol fuel.

Deloitte Brazil

2010-05-03T17:34:00.001-04:00

Deloitte is a well recognized name in the consulting world, operating in 140 countries. In Brazil, Deloitte made its entry in 1911 where they were asked to audit British railroad companies. Today, Deloitte has grown to 4000 professionals working with 132 partners. They have a multifunctional approach (versus a siloed approach) where they provide integrated solutions and command a leading 19% market share of audit services in Brazil followed by KPMG at 17% and PWC at 11%.

They structure their portfolio of advisory services based on industry verticals. In Canada, Deloitte is known to focus on public and financial services whereas in Brazil they focus on manufacturing, retail and the growing financial services sector. Their growth targets are projected to move from 10% to 20% across the board with the highest growth occurring in their consulting services at 25%.

Even with the recent global financial distress, like many other consulting and advisory service firms, they have shifted their focus in branches like their Corporate Finance advisory from M&A deals to restructuring distressed companies and managing them in receivership. According to our contacts at Deloitte, Brazilian banks have been exceptionally successful despite (or rather because of) the financial crisis in the US. The top banks in Brazil are local banks (rather than subsidiaries of foreign parents) and their international presence has allowed them to extend their services beyond retail banking into commercial banking and even IPO’s in global capital markets.

Also, with the upcoming convergence of IFRS (Brazil’s current standard) and US GAAP and Brazil’s increasing role in the global market place, they anticipate having a spike in engagements from clients looking for advice on the implications of the changes in accounting standards and their implications on the complicated tax systems in Brazil (greatly differing by state).
Deloitte is also heavily involved in projects like the World Coup 2014 and the Olympics in Rio where they are not only assisting with capacity management of the facilities for the event itself, but also the legacy planning for the facilities in the future after the event itself is finished (ensuring long term sustainability and viability of the project costs).

Deloitte also has a strong focus on social projects, celebrating their “Impact Day” on June 11, the day of the World Cup, where they have a series of planned activities matching their core of applying knowledge with the development of educational programs. All of their professionals will be volunteering throughout the country taking children to play football with star athletes and preparing creative activities throughout the day.

Because of Deloitte’s unique relationship with a variety of top companies (boasting a client list that includes 80% of the Global F500 companies), they have provided us with contacts for our study tour which we will be visiting over the next few days. They also gave us an insider’s view of details into the developments of sectors within the Brazilian economy including the development of the infrastructure (marking the return of their focus on railroads). They gave us an in depth look at why Brazil is such an attractive country with which to have a presence in the global market place and why they have earned their place among the BRIC countries as one of the top emerging markets.

Port de Santos

2010-05-03T17:28:00.005-04:00

Chinese Feng Shui associates water with money, with its ebbs and flows representing the movement and acquisition of fortune and wealth. At first I had always thought this was a crazy superstition, but some of the most prosperous cities in the world are those that are located on waterways and at some point in their history benefited from trade with other cities (ex. New York, Montreal, Toronto, etc).

The Port of Santos is no exception. Operating along the Tiete-Parana waterway, the Port de Santos is the largest container port in Latin America (and 41st largest in the world). It dwarfs other Latin American ports, the next four largest ports having a combined capacity of about 24% (versus Port de Santos’ 25%) of Brazil’s total exports. Port de Santos acts as a gateway to Latin America, acting as a free port with rail access to Bolivia and road access to Paraguay moving dry bulk, liquid bulk and break bulk goods. Much of the development of industry in Sao Paulo and Cubatao can be attributed to the presence of the port and Brazil’s first hydro electric dam.

We were fortunate to have a boat ride along the waterway as a logistics consultant from Deloitte highlighted the presence of different companies and products being moved through the port. There were cranes towering over massive cargo freighters moving quantities of containers holding anything from sugar to wind farm turbine blades.

There are currently several investment projects underway to improve the infrastructure and information technology systems of the port with the most notable and ambitious being the expansion and dredging of the canal itself: Moving from a 12-14m depth and 150m width allowing 1 way traffic to having a 15m depth and 220m width allowing 2 way traffic, potentially increasing the capacity of cargo movement by 30%.

With the resource race between hungry countries like China, Brazil’s highly coveted natural resources make it a target for investment by foreign countries. While the port is owned and operated by Companhia Docas do Estado de Sao Paulo (CODESP), a government agency, the terminal and services are owned and operated by different companies.

Churrascaria – Nova Pampa

2010-05-02T18:47:00.003-04:00

[LAIST Tour Begins, Fazenda Tozan, Churrascaria – Nova Pampa, Port of Santos, Deloitte, Embraer, Natura, Gol de Letra, Bom Bril, Agencia Click, Nextel Institute, May 6, Rio, Rio Weekend, Petrobras, PREVI]

After our tour of the coffee plantation, we had lunch at the notorious Brazilian style steak house. These steak houses are the ones where you have a small badge on the table. If you want more meat, you leave it on the green “Sim, por favor” side. If you are stuffed, you switch it to the red “Nao, obrigado” side.

We were all excited and started scarfing down loads of sausage, steak, chicken and cheese stuffed cheese (not a typo).
Even when some of us decided to get some vegetables from the salad bar (to prevent us from dying of scurvy), we were quick to discover that most of the “vegetables” were potatoes… And there was slices of roast beef in the salad bar:

With all the beer and meat, those of us who were able to save room for desert were in for a treat: A decadent array of scrumptious and rich cakes. Needless to say, we were ALL sleeping on the bus ride back.

Fazenda Tozan

2010-05-02T18:42:00.003-04:00

[LAIST Tour Begins, Fazenda Tozan, Churrascaria – Nova Pampa, Port of Santos, Deloitte, Embraer, Natura, Gol de Letra, Bom Bril, Agencia Click, Nextel Institute, May 6, Rio, Rio Weekend, Petrobras, PREVI]

Tozan Farm (Fazenda Tozan) was established before the independence of Brazil in 198. The name comes from “To” meaning East and “Zan” meaning mountain, an allusion to Tai Zan mountain, and was a pseudonym for Hisaya Iwasaki, of the Iwasaki family – founder of the Mitsubishi Group.

The farm first belonged to Floriano de Camargo Peneado and originally only grew sugar cane, the first major crop of Brazil. His son, Caitan-Mor Floriano de Camargo Peneado took over the farm in 1854 and diversified the crops to include corn, rice and finally coffee. In 1885, the farm intensified its coffee growth. However, 1925 saw the “super growth” of coffee, dramatically increasing the supply of coffee much faster than demand, causing the price of coffee to plummet.

In 1927, the Iwasaki family, wanting to diversify their financial holdings in anticipation of financial “stress” (as it manifested in 1929 in New York), bought a large number of farms around the world including Tozan Farm. After purchasing these farms, they used their economies of scale to leverage technologies from different areas (for example, the “Vespa de Uganda”, a technology used to fight coffee “plague” affecting the plants). They also further diversified their farm holdings to include cotton, cereals, “practical reforestation” and Nelore cattle.

Since arriving in Sao Paolo, the popularity of coffee increased as it started following the coastal border of Brazil. Today, 65% of the coffee in Brazil is Arabica (sweeter) and the rest is Robusta (stronger).

The history of coffee itself is quite interestingly international as well. Originally discovered by an Ethiopian Sheppard from the city Cafa, he noticed that his sheep strangely “acted more aggressively” when they had eaten the fruit of a particular plant. Coffee then began to spread from that region and found its way to the Muslim world where the Arab’s were the first to roast the coffee beans and prepare coffee in the manner which we recognize it today (originally the beans were taken for their sweet juice). The Dutch, famous navigators, introduced coffee to Europe through Venice, where the first coffee shop was opened (and we are told is still there).

Peiro was translating for our guide, who didn’t speak any English, however, there are somethings for which you don’t need a translator. His passion for coffee was quite apparent as he was animatedly speaking Portuguese while gesturing to the various devices and machines used in the past for the harvest and preparation of different varieties and grades of coffee beans.

Latin America Study Tour Begins

2010-05-01T18:00:00.003-04:00

[LAIST Tour Begins, Fazenda Tozan, Churrascaria – Nova Pampa, Port of Santos, Deloitte, Embraer, Natura, Gol de Letra, Bom Bril, Agencia Click, Nextel Institute, May 6, Rio, Rio Weekend, Petrobras, PREVI]

Our study tour begins on a lucky note, as all of us are able to come in on the same flight leaving Toronto (for the first years, this is immediately following our Operations Management exam and a quick round of pints at Bedford) where we had a quick bite and night cap at Pearson.

Upon arriving in Sao Paolo airport this morning, we were greeted by Peiro, our guide and Santana, our bus driver who took us to the hotel. Laura was there cheerfully waiting for us and welcomed us with a round of hugs. After the necessary paperwork and unpacking, a few of us felt a bit adventurous and began wandering the city under the leadership of “Bovespa”.

We found a fresh juice shop where we ordered a variety of exotic fruit juices: Mango, papaya etc. We proceeded to find a nice little restaurant serving a buffet of local fair. It was exceptionally interesting to try to explain that some of us were doing the all you can eat R$ 20,80 (R$ 1.6 = CND$ 1) while some were going for the food by weight R$ 2,80 per 100g.

After a bit of exploring in the city we found a beautiful lake with locals enjoying the good weather. Tomorrow, our study tour begins with a visit to a coffee plantation. A heavily resourced based economy and the B in BRIC countries, Brazil has a bright future as was highlighted in the Toronto CFA talk on Geopolitics of Investing. Coffee was one of Brazil’s earliest successful and staple exports and continues to play a large role in their economy today.

(Half) DONE!

2010-04-30T13:49:00.003-04:00

Well, no one said it would be easy. In fact, I'm quite sure everyone was saying it would be really hard. But we finished the operations exam (and by extention first year of our MBA program).

I think everyone generally agrees that Operations Management is the toughest course. And although I'm told engineers are supposed to have an advantage over our classmates when it comes to this course, I think my advantage may have left me when I wasn't looking.

Anyways, the class is heading to a variety of events tonight to celebrate, so I'll probably keep this short. Everyone's energy level has kicked up a notch as people are excited to move on. Some summer jobs are starting straight away on Monday May 3rd. A bunch of us are going on study tours (Latin America study tour flies out tonight and I'm told India study tour flies out this afternoon).

I'm excited to be going on the tour and will certainly keep a better blog post pace than recently.

Flirting with 0.5 MBA

2010-04-26T13:52:00.003-04:00

We have entered exams week for Q4, the final quarter of our first year MBA program. We've started it off today with Managerial Accounting. Tomorrow, we have Global Managerial Perspective (GMP) and Friday will be Operations Management.

The other two courses, Business Ethics and Integrative Thinking Practicum (ITP) have major team assignments due, but most teams have finished this work well in advance of exams in order to focus their energies.

I've just moved to my new place closer to work downtown for the summer. I'm subletting from a friend who will be gone. I must say, it feels much more human to have moved out of my notorious "haunted house" in Chinatown near Spadina and College. In all fairness, a good friend of mine gave me some advice for first year: "You'll be at school most of the time until late anyways, so just get a place nearby so you can rest your head at night" and he was absolutely right. As much money as I would have saved staying at home, it was certainly worth the marginal cost to live close to school.