In order for a recommendation to make sense, it must be framed in the context of key industry trends that affect the company you are pitching to. At the highest level, any company in any industry will want to pursue a transaction in order to make the company more competitive. Therefore, the job of an investment banker is to provide management teams with ideas that make sense given the existing competitive environment and key industry trends.
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The primary financial and operating metrics that we should highlight in an industry overview should be identical to the financial and operating metrics that we showed in the company overview. The same metrics that are most relevant to the company you are pitching to are, logically, the same metrics that the company’s competitors are trying to optimize. By comparing a company’s top-line growth, margins, leverage, and market values to averages across the industry, this type of analysis can provide useful benchmarks regarding valuation, market share, and strategy.
However, it is important to keep in mind that no two companies are exactly identical, and it can be a wise idea to highlight these differences. It may make sense to divide industry analysis by industry subgroups, geographies, or customer segment. For example, a primarily gold mining company may own assets that produce base metals as a by-product. Different mining assets in different geographies may be exposed to different levels of geopolitical risk. Framing the strategic recommendation with these key considerations in mind is a powerful tool to win over management.
Investment bankers must be able to not only identify historical trends in the industry but also gain an insight into key industry trends that are expected to continue. For example, a profitable company operating in an industry that is being disrupted by new technology may be an opportunity for an investment bank to pitch a strategic integration. In order to form a strong thesis on what is expected to happen in the future, an investment banker will need a solid understanding of internal and external forces that act on the company and the industry as a whole.
At a high level, the easiest way to analyze these trends is to look at how much the different players in an industry are making and how much they are planning to spend to continue making more. To break this analysis further, we can identify the company’s sources of revenue and identify segmented trends across competitors. The investment banker should be able to identify any pain points of the company and provide the medicine to fix the areas that are hurting. Are sales hurting in a particular revenue stream? Why is this happening? Is the revenue stream worth salvaging? Or is it suffering from structural decline? If Company A buys Company B, can this issue be fixed? If Company A buys Company B, are we taking a key resource that a potential competitor can use off the market? These just some of the questions to think about when performing a segmented revenue analysis.
Regarding spending, an investment banker can break down this analysis further by comparing the liquidity profiles across key competitors or potential target companies. Forecasting operating cash flows across competitors gives us a baseline on what companies are capable of pursuing organically, and which pursuits require further capital. By comparing which industry players are more leveraged than others also gives us an indication of the companies that are capable of pursuing opportunities, and we are able to infer which capital allocation priorities are available across companies by looking at their debts’ yields and maturities.
Putting it All Together
To give an example, the restaurant industry is undergoing significant consolidation and is being disrupted by ‘Fast Casua,’ a relatively new dining category that is disrupting the industry. Breakfast has historically been a highly lucrative daypart. Dinner has traditionally been the most competitive daypart. Perhaps your bank may pitch an acquisition of a strong breakfast franchise like Cora to a restaurant banner consolidator like Cara Operations utilizing this industry’s trends. If the company is overleveraged, selling off an underperforming dinner banner to deleverage may be a strategic alternative. Or perhaps your bank may approach Chipotle to persuade company management as to why the timing of an IPO is right given the industry forecast.
Investment bankers will utilize many different sources to get a sense of what is happening in the industry they serve. Management Consulting firms such as McKinsey or Bain will issue periodic industry research reports. Sell-side equity research shops will also issue industry reports, industry primers, and summary tear-sheets. Some industries have industry research tools unique to the industry. For example, the weekly Random Lengths report provides valuable price information for the lumber industry. It is best practice to compare statistics across different research sources and distinguish what is fact and opinion when formulating your pitches.
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