This is an excellent investment banking interview question which shows that the interviewee thinks about corporate finance applications outside of theory.
A lot of candidates have the technical interview questions rehearsed and have great answers about:
Why investment banking?
Can you work the hours?
Are you really passionate about finance?
And then after convincing you that they like investment banking so much, they are hit with this question and draw a blank, revealing that they do not actually read Barron’s for merger ideas and they do not frequent DealBook to see which deals fell apart.
Mergers and acquisitions are the bread and butter of investment banking. Not all of them are good – as evidenced by share prices plummeting for the acquirer post announcement. Some of them are really bad ideas and the stock of both companies fall, target and acquirer (assuming there is a stock component to the merger), leaving the board of directors of both companies to scramble out with a press release stating what the market has not digested.
Fortunately, in an investment banking interview process, candidates do not actually need to pitch a good merger – they just need to sound like they have thought about it. Similar to the stock pitch – half of the people I have hired in investment banking recruiting processes gave stock picks that ended up losing a lot of money – with awful ideas in recent memories including Groupon, GoPro, IBM (Warren Buffett owns a lot of it!) and General Electric. By the way, if I were to buy one of the four duds right now it would be GE.
So in preparing for an interview, let us save you a few steps and guide you towards what to look for.
First, start off with two companies that are in the same supply chain vertically or horizontally. That means either a supplier or buyer or competitor. It is just far easier to spin your narrative this way – and the markets tend to agree with this, companies without obvious synergies get whacked when they announce a merger. Horizontal ones are easier to talk about, so look for two companies that are focused on the same general product.
An easy one is Burger King (Restaurant Brands International) and Dunkin’ Donuts (DNKN). I am not saying this is actually a good merger idea, but it is a great merger pitch idea in terms of getting you a job. Now, look for:
Geographical Synergies – If the companies operate in different locales, for instance Dunkin’ being a strong American franchise while Burger King is global, contacts from Burger King can get Dunkin’ in with local authorities and expand where there are consumer tastes suited to Dunkin’. If Dunkin’ is popular in certain parts of the US and pair up with Burger Kings across the nation, they can have supply chain synergies as they save on shipping costs moving product to the locations.
Maintain Leading Position in Product – Assuming that Burger King patrons would also eat donuts, cross selling donuts would ensure the Dunkin’ Brand would be front and center – widening the lead on Krispy Kreme (owned by JAB Holdings). In reality, Dunkin’ Donuts are terrible compared to Krispy Kremes but the interviewer will not interrupt you to make a somewhat subjective point. Sales could go up.
Deleveraging via All-Stock Merger – If Burger King is struggling and being seen as too highly levered while Dunkin’ is low debt and high cash flow (I have not checked their financials, but you will have to if you are preparing this pitch), this could be an opportunity to delever using an all-stock transaction followed by the aggregate cash flows of two food and beverage giants. This is especially helpful if Dunkin’ wants to expand and has capital expenditure plans but needs to raise capital to do it. Being folded into the larger Burger King entity allows them to do this without needing access to outside capital.
Size Premium – While CEOs sometimes want to buyout companies for the sake of managing a larger company and having their pay benchmarked to megacap peer CEOs, sometimes getting bigger does make sense from a buying and selling power perspective (Porter’s Five Forces from business school) and even a liquidity perspective. Two $300 million companies may have steep liquidity discounts but a larger float with a $600 million company may not.
Sometimes this turns into “how accretive is this to cash flow or earnings?”, in which case you may have to think about the merger math – what premium are they paying, what is the EBITDA of both firms, what is the value of synergies and what is the value of interest on new debt issued to fund the transaction. If you are suggesting stock, how big does this increase the share count.
That is very hard though and beyond 90% of investment banking interviews – saved for Elite Boutiques only.
Pitching A Private Company Buyout
If you want to get really fancy, you could even suggest that Burger King should snap up a smaller private restaurant backed by a bunch of private equity firms – for example, Shake Shack (SHAK) before they went public. Or Potbelly or Jimmy John’s – we know they all suck now but it is something to talk through.
The private equity firm could want to realize value today and monetize but find the equity markets unattractive for issuance right now. They could also not be large enough to float and suffer from a liquidity discount but not want to wait out the time to expand. Or, they need to raise capital but again are not large enough and are not at an appropriate sweet spot for debt.
If you can communicate this to your interviewer, they will be very impressed. If they stop you and ask for two public companies though, this will not work (because they want to lead into accretion dilution).