Yesterday, I went to a friend’s place for dinner. This friend of mine works in one of the biggest domestic investment banks in India
We concluded that how some people, by just being at the right place at the right time ride economic cycles and create wealth that would have been so difficult, if not impossible, to make in the normal course of events. I have to admit that some of the cynicism and criticism was unwarranted and harsh from our side. However, we started recollecting the interesting faux pas that we have faced in our professional lives. Some of it was because of the genuine mistakes of the concerned persons; the others reflect the professional caliber of the seasoned people (usually senior professionals) in the financial services industry.
Here is a small list (each one of the below is a real incident):
- A partner in a fund was evaluating a project; his CEO had already given a consent to the deal and the partner was making the financial model of the project. He knew the deal had to be done and so he wanted the projections to justify the valuations that the fund had agreed to. The analyst working on the transaction prepared a DCF model, used aggressive assumptions and did what ever he could, but could not bring the desired valuation. The partner gave him many suggestions to pump up the valuations but after trying everything also, no significant progress was made. Exasperated, the partner finally asked his analyst if he could do a DCF of the PAT instead of the cash flows to see if that gave a better result? (unbelievable but true!)
- Two partners in a fund were discussing the valuation of a company where the fund was about to infuse money; there was some confusion as to whether the USD 350 mn company valuation was pre money or post money. A lot of debate took place and after a series of emails over 2-3 days, they realized that it was a secondary transaction!
- A investment banker was having a brainstorming session with his client. The promoter needed funds in his company but did not want to dilute equity. The company did not have the repayment capacity of expensive debt and given the market conditions cheap debt was simply impossible. After a long and draining brainstorming session, the banker suggested that the promoter issue ‘convertible equity’ which could be issued as equity and then later be converted into debt. In this way, he could both retain control and not pay high debt cost in the immediate future. The promoter was stunned!
- In this case, a financial investor had made an investment and exit from the investment in less than 6 months. He had barely managed to recover his capital in the process. While preparing a track record of his performance he listed down each investment and the corresponding IRRs achieved in the same. For this specific investment also he calculated the IRR using the XIRR function in MS Excel. To his utter delight the XIRR function threw up a high double digit IRR ! His joy knew no bounds. My explanation to him that the IRR as method of return computation cannot be applied on investments of less than 1 year duration fell on deaf years. The compendium of track record was shared with the global board of the financial investor.
- My colleague was trying to raise debt for one of his real estate projects. He met senior bankers working in a MNC bank. During one of the discussions, they were evaluating the repayment capacity of the project and how much overall cash the project would throw up. To my colleague’s utter surprise, the bankers were using the PAT figures to assess the project’s repayment capacity. He protested saying that the total cash flow of the project should be considered, i.e., PAT + equity, as that is indeed the total amount of cash flows the project would generate. The idea was shot down by the bankers as they claimed that equity would be “used up in the project” and hence the free cash flow available would only be PAT !!!
