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Below is an excerpt from “The Accidental Investment Banker”, in which Jonathan Knee describes his first experience with investment banking - a summer internship with Bankers Trust in London in 1987, where he was introduced to the vagaries of M&A. His first task was to compile a “pitch book” for Hillsdown Holdings under the guidance of Andrew Capitman, a senior M&A banker transferred to the London office from New York.
It turned out that Hillsdown was a very sensible company for an American investment banker to target. In the financially conservative United Kingdom, Hillsdown had been described as “the country’s most acquisitive company.” Founded in 1975 by a London lawyer and a butcher-turned-investor focused on buying undervalued companies on the cheap, Hillsdown went public a decade later. The broad-based conglomerate purchased well over 100 companies in the next three years.
Although the part of Hillsdown that dealt with chicken, Buxted Poultry Ltd., was not its largest division, Capitman was delighted to have gotten the meeting. And he clearly wanted us to have something important to say when we got there.
Chickens. I didn’t know a lot about chickens. It was my favorite meat. I knew that people who preferred white meat were discriminated against at KFC through the imposition of an unfair surcharge. I also vaguely remembered that a great-grandfather in Poland killed chickens for a living and that my grandmother bragged about this to neighbors with fathers who held less lofty positions. The sense she gave me was that chicken killer (in Yiddish a shoichet) was just below chief rabbi of Warsaw in terms of holiness and prestige in the Jewish community. But this pretty much exhausted my knowledge of, and indeed, interest in chickens.
Where to begin? I went to the library and immersed myself in all things poultry. It turns out that there were quite a few companies that involved themselves with performing a variety of activities on chicken carcasses. But which company and which activity Hillsdown should target was far from clear to me. Buxted Poultry already appeared to do most things one could think of to dead chickens. But since Buxted seemed to focus on murdering British chickens, it seemed logical to suggest opportunities to do the same back home in America.
I kept reading lots of equity research reports about the publicly traded U.S. chicken killers and noticed that the post-mortem protocols of these companies fell into two main categories—cutting them up in various ways to be sold as chicken parts and performing “processing” procedures that turn unspecified body parts into frozen patties, nuggets, and strips (we’ll call this latter activity PNS). The research reports described companies with PNS as “value-added” processors, which apparently justifed higher valuations.
By this time, there were only a couple of days to go before our meeting at Buxted, so I went to Capitman’s office to give him the results of my research. He leaned back in his chair and listened patiently as I described my recent investigations. When I was finished, a silence filled the room. “That’s it?” he cried in disbelief, moving his head and arms threateningly toward me across his desk. I wracked my mind for some incremental “nuggets” of minutia about chickens and the companies that kill them and frantically began to spout them out.
“No, no, no,” he cut me off, standing and waving his arms as if to swat away my irrelevant words.
I stopped and we just stared at each other. Then a flash of realization crossed his face and he slumped back in his chair. “Oh my God,” his expression seemed to be saying. “The meeting is in two days and I’m dealing with an idiot.” Finally, he leaned forward slowly and said, carefully enunciating each one syllable word as if to a child.
“What . . . should . . . they . . . BUY?” The first three words were spoken softly, but the last exploded from his mouth as his head moved a few more inches toward me.
Despite my business school education, I had never really thought about actually valuing a company. I knew a lot about these chicken companies, but really never considered whether any represented a particular bargain from a value perspective.
“Oh sure,” I lied. “I’m bringing that tomorrow. I just wanted you to know how I was thinking about the industry.”
He sat back in his chair, eyeing me carefully. I was pretty sure the jig was up.
“I wanna see it first thing,” he said, waving me away and returning to his Financial Times.
I returned to the research reports and desperately focused on the sections headed “Valuation.” Almost all the reports for all of the companies had some version of a “buy” recommendation, but none of the reports compared one company favorably or unfavorably to another. The valuation metric for all of these companies seemed to be a “price-earnings ratio” or P/E. The P/E basically told you at the current stock price, how many dollars (or pounds) an investor is paying for every dollar (or pound) of earnings. I had no idea how earnings were actually calculated or what the differences were between different countries’ accounting methods, but I did know that a higher P/E meant more expensive and a lower P/E meant less expensive. This, at least, was a start.
I also remembered that analysts said that companies with more PNS deserved to be more expensive. Then it hit me. I might not know anything about valuation or accounting or, if truth be told, chickens. But I had been a math major. (O.K., it was a joint degree along with philosophy and a minor in theater, but I remembered the basics.) And I certainly knew how to put points on a two-dimensional graph. So if you had six chicken companies each with a different P/E (the y axis) and each with a different percentage of revenues (the x axis) coming from PNS, I could certainly chart a graph with six data points. Using the spreadsheet available at the time, Lotus 123, I could print out a very attractive graph with the bold heading: The Price of Poultry.
Then I noticed something wonderful about Lotus 123. If you highlighted the six different (x,y) coordinates on my little graph you could click on an icon called “regression.” Regression in this context is a statistical term that enables you to draw a straight line on the graph that best approximates where the six data points are. In other words, it gives you the equation of the straight line that is closer to those six points than any other straight line and tells you on average (at least as far as these six companies are concerned) how much incremental P/E is attributable to every incremental percentage of PNS. The idea was simply to find the mathematical relationship between how a chicken company was valued and how much of its chicken was PNS.
Once Lotus drew my straight line I was home free, even if it was 3:00 am by the time I figured all this out. We could now claim to have developed the magic formula that connected what the shares of chicken companies were really worth to what they did with those chickens. All the companies with a data point above the line were “expensive”—the price was high for the level of PNS you were getting. And the ones below the line were a bargain! I found the company represented by the point with the greatest distance below the line and declared it the biggest bargain in the global poultry firmament.
Now, of course, I knew this was mostly nonsense. Lots of other factors can impact even a chicken company’s P/E other than PNS. Is management good? Is there too much debt? Is there a big lawsuit pending? What accounting method do they use? And objectively “cheap” or not, an entire other set of questions, both operational and financial, affected whether a particular company would make sense for Hillsdown to buy. But the desire to get an hour or two of sleep before presenting my results to Capitman allowed me to convince myself that it was good enough.
The next morning I stopped by Capitman’s office with the results of my labors. He looked up from his Financial Times warily and said nothing as I approached. I presented my page and took him through the thinking and calculations. As I explained, I saw the tension in his body subside and I even think I saw the beginnings of a smile. He went back to his Financial Times without looking up. “I wanna see the whole book before I go home tonight,” he said waving me away.
Now as a practical matter, this single page was all we had to say even of arguable importance to the CEO of Buxted, who we were to meet. But the rest of my day was spent bulking up the book with Capitman’s biography, laudatory descriptive material about Bankers Trust in general and its previous work in the food industry, several-page overviews of each of the six companies including Hillsdown itself, a selection of relevant research reports on the companies and industry, a summary of how all the six companies traded in the public markets and how their stock prices had performed, and descriptions of previous M&A transactions in the food industry. And voila, a page becomes a full-fledged, 50-plus-page pitch book.
As it turned out, Capitman had never met David Newton, CEO of Buxted, but had cold called him possibly after reading some quote in the Financial Times suggesting they were planning to be acquisitive. “We’ve been doing some very innovative thinking about your industry,” I overheard Capitman say to him as he confirmed our meeting, “very proprietary stuff.” In general, analysts and associates, and certainly summer associates, are thrilled to have the opportunity to actually attend a meeting at which material they worked on is presented. But frankly, I was afraid Newton might roll over in hysterical its of laughter. I imagined 101 reasons why the company we had identifed as too cheap not to buy might be a complete nonstarter for practical reasons obvious to anyone with even passing familiarity with the industry. I imagined the deadly glance across the table from Capitman that would ensue as a precursor to my permanent exile to some unattractive corner of Bankers Trust for the balance of the summer.
The meeting began as I watched Capitman perform the investment banker’s rendition of the old parlor trick perfected by gypsies and fortune tellers. Just as Professor Marvel drew the runaway Dorothy out with stolen glances at the contents of her bag in The Wizard of Oz, Capitman drew out the client, using whatever tidbits he could from Newton’s banter to feign increasing familiarity with the subject matter, then used that to draw out even more information. The point was to create the sense of intimacy necessary to gather as much information as possible before moving ahead. Once Capitman had learned everything he could from Newton and convinced himself that what we were proposing would not be a complete anathema to what Hillsdown was considering strategically, he dramatically produced a copy of our thick pitch book.
“I think I mentioned on the phone that we have been doing some very serious thinking about your sector,” he said conspiratorially, still holding the book closely as if unsure whether to share its valuable contents. “We see a window of opportunity here for those few companies who are in a position to be consolidators,” he said as he slowly pushed the precious cargo across the table.
“The question is not whether but who, what, and when,” said Capitman with an apparent self-confidence that left me breathless. I wanted to just open the book to The Page and see the room to await the reaction.
“What we’ve done here is identified the what. Who and when frankly will be determined by which of you has the vision and the courage to move first. The reason we are here is that we think it should be you and we think it should be soon.”
I would later be able to recognize this as a version of what investment bankers call the “Dare to be Great” speech. But at the time I was stunned. He had never met this guy before. And he hadn’t even told him the idea yet, which I for one still wasn’t sure made any sense at all. Yet, so far anyway, Newton seemed hooked. Capitman began going through the book with remarkable self-assurance, using each page to draw out Newton more. Then we got to The Page. I literally held my breath. Capitman explained. There was a silence.
“Interesting,” the Newton said thoughtfully. I saw Capitman try to stop himself from smiling, unsuccessfully.
In the cab on the way back to the office, Capitman was almost giddy with joy. He barely acknowledged my presence and appeared to be talking to himself. “That,” he said with emphasis to no one in particular, “was a great meeting.” He could barely contain himself in the cab and bounded out the moment we arrived back in the city, presumably to relate his success to anyone who would listen. What a strange business, I thought to myself. I am definitely not doing this for a living.
Excerpt from THE ACCIDENTAL INVESTMENT BANKER: INSIDE THE DECADE THAT TRANSFORMED WALL STREET by Jonathan A. Knee. Copyright (c) 2006 by Jonathan A. Knee, an excerpted by permission of Oxford University Press, Inc.