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Module 3: Interviews
Interview Transcript (Sample)
“If I Gave You $100,000, What Would You Do With It?”
“As a general idea, I prefer fairly long term passive holdings and I don’t like to chop and change my investments too frequently.
And my fundamental thesis over the next 5 to 10 years is that there’s going to be fairly low inflation, given that where the world is at the moment, where the domestic economy is fairly weak, and the European economy even weaker and potentially going to get worse, and that is a large proportion of the world’s demand is in Europe and the US – demands for goods and demand for services – and then you have a huge amount of supply which has been built up over the last 10 to 20 years, particularly in places such as China.
So what’s happened is that demands moderated, but supply has built up so much is that I think there is an underutilization of assets which is a deflationary force.
And this lack of demand, and I suppose glut of supply, is going to lead to a long term period of fairly low inflation, even though central banks are printing trillions of dollars, I still think that the deflationary forces are going to win.
And you are going to be in a fairly low return environment, with potential for periods of economic weakness or recessionary growth both here in the US and in Europe in particular.
In that context from a total shareholder return perspective, so from capital growth plus your dividend or distribution yield, I think what’s going to be really important is that you grow your dividends.
And that’s where I would be looking.
Now that might all sound very conservative given I’m quite young, but I’m looking to protect on the downside with fairly safe stocks that pay strong dividends.
And so if I was given $100,000 I would look at 3 to 5 companies which have strong market positions, have relatively capital light businesses – business which are very high users of capital, such as the airline business, a classic example, or a mining company, they will typically be very exposed to cyclical movements in the economy, and they will also be voracious users of capital which makes it very difficult for them to pay high dividend yields.
So I would look for a company with a very strong market position which isn’t necessarily so heavily tied to the ups and downs of the economy, which uses fairly modest amounts of capital in its business and can therefore maintain its distributions.
So even though you might not get any movement in share price over the next 3 to 5 or 10 years, you will be getting strong dividends and that’s going to generate a majority of the returns.
And this is in an environment where fixed interest products such as treasuries or very safe corporate bonds might only be yielding you inflation, at best, at say 2 or 3%.
So you’re not really getting ahead by owning fixed interest products with supposedly very good risk credentials, European treasury debt aside.
So I’d be looking at strong corporates that pay solid dividend yields.
There are plenty of franchises you can think of, might be like a Coca Cola, might be like an insurer, or assets being sold on a distressed basis, take Munich Re for example, a reinsurer in Europe that has paid a growing dividend for the last 40 years…
…and even though a lot of European assets are being priced at distressed levels at the moment, it might still have market power, be sufficiently well capitalized to continue paying a very strong dividend.
I’d be looking at close to 100% in stock, and if not 80% in stock and then maybe a bit of cash on the side which you can then utilize into say treasuries or cash or other very liquid cash equivalents, and then you could utilize that into any downswings in the equity markets to pick up mispriced assets.”
“If I Gave You $100,000, What Would You Do With It?”
Well done kid, not bad!
Now let’s move onto our thoughts…
We LOVED this answer because the thinking that went into it was immense.
But we also HATED this answer because it was like the ramblings of a 4-coffee-fuelled analyst at about 3am!
The answer also missed an important point…asking who the money was to be invested for…you (yourself) or some hypothetical investor (eg a 60 year old retiree…hang on, who the f**k can retire at 60 with this market!).
The student just assumed we were talking about giving him the money so he could invest it for himself.
But since this is often asked to test out your fund management skills on behalf of a client, this is a dangerous miss. That said, its not too major, as bankers will usually let you rant ahead on what you’d do with the money for yourself.
Okay, back to it…
So the student spends a lot of time talking about the shape of the world economy, and although it’s great, its all loaded at the front of the answer. This is baaaad.
Bankers will be faaaaaalling asleep thinking;
“What’s this student on about, why don’t they just answer the question?”.
ie you should FIRST tell them what you would do with the money, and THEN set about explaining the reasons.
We just need to FLIP this student’s answer on it’s head.
The actual answer he gives is great, but it’s the reasoning we care about…and it woooorks!
You see, just like in maths class it doesn’t really matter what answer you arrive at (eg here, 80% stocks, 20% cash), but rather how you explain it and justify everything.
Whilst the student did well explaining how certain assets classes were providing very poor returns, and thus why stocks were attractive, what was particularly great were his references to his personal situation…ie tailor making the answer to the needs of the client…which in this case he decided was himself!
So overall, great answer, just could have been delivered and structured in a much clearer, smarter way.
“Walk Me Through An LBO Model”
“Well, the first thing to realize about LBOs is, I guess, what the rationale is and why they are done. And if you start thinking about that, then the model kind of works itself out.
So the scenario is a company with fairly stable cashflows, which will typically be conservatively geared (ie not have much debt), and as a result of that it might be a low growth company with solid stable cash flows and relatively low debt.
The return on equity of that company will be quite low, because it will be lowly geared, therefore a large potion of the company’s assets are funded by equity holders.
A private equity play is to then take that company and acquire it by injecting it with a huge amount of debt and only a small slither of marginal equity, which allows the private equity company to pay more for that company than say a trade competitor might.
And so the PE player can get away with only using a small amount of it’s precious managed funds – and instead can use bank or bond holder debt to fund the acquisition.
What it’s really looking at doing is leveraging the company up, whereby the cash flows required from the private equity firm are smaller up front, and what this does, this has the effect of…
…at the revenue line nothing should really change, and at the expense line quite often what you would assume for an LBO model is that the private equity firm will reduce costs and then there will be a huge increase in interest expense, but of course the interest expense on the debt is tax deductible.
So the profit then isn’t so much impacted, but the cash flow is.
The higher the level of gearing and the less equity that is put into the company, the higher the return on equity all other things being equal. Although the volatility of the return on equity will also increase substantially.
So in an LBO model you would be assuming that a whole bunch of debt, which you might assume at a cost of say 6 or 7%, will be substantially less than your IRR hurdle of 20 or 25%.
You would then assume in an ordinary set of circumstances, that a private equity buyer / sponsor, would hold the investment for 4-7 years, or even less in some cases.
Whilst servicing this high volume of debt, they would keep the debt in place, and improve the operations to the extent possible, and the debt would be serviced with the stable cashflows.
Then you would be looking at an exit, and the exit for a private equity firm might be either via an IPO or a relisting of the company, or via a trade sale, and that’s where the bond holders of the private equity debt are typically paid back from the proceeds that come from the business being sold.
The private equity buyer will make money from the deal, because presumably the value of the business will have improved over the holding time, assuming they have run the operations soundly, reduced the cost base of the business and collected the benefits of the interest tax shield along the way, and then assuming they have originally acquired the business at a low equity multiple and can now successfully flip it into a high multiple.
And yeah, that’s how they will typically achieve their return on equity or IRR hurdles of 20-25% or more.
“Walk Me Through An LBO Model”
Solid answer. The student displayed a veteran-esque level of real world knowledge with this answer. Let us explain this because it’s really important.
When the student mentioned how “precious” a PE players funds are they showed real world knowledge.
When they mentioned how the P&L is affected vs the CF statement they showed real world knowledge.
When they mentioned a probable cost of debt they showed real world knowledge.
When they talked about holding time they showed real world knowledge.
When they talked about ROE hurdles and gave real numbers they showed real world knowledge.
This is the type of real world info you too want to be filling your answers with.
It will take you from student to baby banker instantly. In a banker’s mind it differentiates you in so many ways.
Most of all it shows you love finance, that you are a lifetime student of it…
…and that you wake up with the WSJ freaking plastered across your face!
And it’s this sort of impression that leaves bankers with a strong gut feeling that you’re the right guy or gal for the job.
But this is not a love in. The student definitely had some room for improvement.
Let’s take a look at what annoyed us about the answer…
What was wrong with this answer?
The student’s answer was a bit muddled at times.
When you read the above transcript you can see the student changing mental gears from time to time. His sentences were at times filled with mental farts!
Now it’s okay to ‘think’ in an interview room and most students will also go through this. But it’s so easy to avoid. Just get those 3-5 dot points in your head when you’re prepping.
Say for this answer there are 5 points to cover and you can just say near the start of your answer…
“There are 5 major parts to an LBO; the target company & acquiring company, the leveraged buy out, the transformation, the exit and the return. So firstly, with the target company what you would typically find is…”.
Once again, this is all about explicit signposting – the way Jobsy did back in the day when he was the keynote master.