It seems that we have financial tools (Factset, Bloomberg, etc.) out there to create pro-formas statement. Or as the last resort (or first), you can outsource this task to India: http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aBrxeTBQQrWs# So, what value do sell-side analysts and I-bankers add with their financial models? I am not arguing about their market insight, but specifically about financial models.
bloomberg and factset have historical pro-forma statements, but the main purpose of financial models isn’t to record the past, it’s to show you what could happen in the future. to my knowledge bloomberg and factset don’t have working models that allow you to plug in drivers/inputs to forecast future earnings and cashflow. i wouldn’t be surprised if they had this one day though… in terms of financial statement analysis, the argument for the value of sell-side models would be that in delicate situations a sell-side analyst would be able to use industry expertise to make proper one-off adjustments to more accurately reflect underlying operating earnings. i think when people think of “great models” they think of something that’s super complex, with hundred of lines, layers of drivers and a bazillion circular references. what really matters is getting the inputs right, and 99% of the time a simple model with sensible inputs can get the job done just as well.
You have to make a model in order to understand the company and to figure out why the stock is priced the way it is. If you just look at someone else’s model it won’t help you much. CFA material should spend more time on this stuff.
abacus Wrote: ------------------------------------------------------- > Or as the last resort (or first), you > can outsource this task to India: Maybe this is the future, but for now there doesn’t seem to be the expertise, though I know a London based company that is aiming to tap into this market. I tried to convince my old company to let me start up the Indian side, but they were too old school for this. > http://www.bloomberg.com/apps/news?pid=newsarchive > &sid=aBrxeTBQQrWs# No generic model will ever model all situations. Many people have tried to write such a model, but in the end it usually becomes so large that it is impossible to change when required. An understanding of the structure therefore is very important. > So, what value do sell-side analysts and I-bankers > add with their financial models? I am not arguing > about their market insight, but specifically about > financial models. Accuracy, and the ability to make changes. For a simple model this may not be much, but for something complicated that is finely optimised this is very important. As an aside, I would like to write a financial model with a software interface such that anyone could create a good functioning model. The difference would be that the end product would be simple in structure as it would only have the necessary elements and would not be hindered by unnecessary complexity. The problem is I do not have the software skills and I don’t think there would be much money in it… so on to next idea.
FactSet and CapitalIQ both put out template models that are linked to pull down capital market information- just change the ticker and go. The models are okay, but I’d personally rather have done it myself or have had it done by someone I know/trust just so we know where all the bodies are buried and all the assumptions. This reminds me of a passage from ‘Den of Theives’ where Tom Hill (who’s now with Blackstone) talks about the benefit of putting together all the models as a junior analyst/associate- by the time you are more senior and are actually making decisions you’ll have much better understanding of the pressure points/value drivers. In terms of outsourcing to India, it may be the wave of the future but I’ve heard that it can be hit or miss from a quality standpoint. I have an accountant friend who works at Deloitte. Apparently, whenever they receive a valuation model for financial reporting purposes (in PDF format) some poor soul in India has to check, tick and tie the entire thing. That sounds so miserable… This said, I don’t think financial modeling is the be all, end all. It seems every two weeks people are posting about Dealmaven, Wall Street Prep, etc. and trying to figure out how much it’ll help them land a job. It’s not rocket science and certainly isn’t a silver bullet.
soma80 Wrote: ------------------------------------------------------- > FactSet and CapitalIQ both put out template models > that are linked to pull down capital market > information- just change the ticker and go. The > models are okay, but I’d personally rather have > done it myself or have had it done by someone I > know/trust just so we know where all the bodies > are buried and all the assumptions. This reminds > me of a passage from ‘Den of Theives’ where Tom > Hill (who’s now with Blackstone) talks about the > benefit of putting together all the models as a > junior analyst/associate- by the time you are more > senior and are actually making decisions you’ll > have much better understanding of the pressure > points/value drivers. > > In terms of outsourcing to India, it may be the > wave of the future but I’ve heard that it can be > hit or miss from a quality standpoint. I have an > accountant friend who works at Deloitte. > Apparently, whenever they receive a valuation > model for financial reporting purposes (in PDF > format) some poor soul in India has to check, tick > and tie the entire thing. That sounds so > miserable… > the miserable soul is more likely to be a college student looking to make some money during his college break rather than any qualified accountant. that should put things into perspective.
Are there any sources/material that you recommend for someone studying for the Level I? I’d like to improve my modeling skills on the side (and eventually land a job on the street)
cab454 Wrote: ------------------------------------------------------- > Are there any sources/material that you recommend > for someone studying for the Level I? I’d like to > improve my modeling skills on the side (and > eventually land a job on the street) Look at Financial Modeling, 3rd ed by Simon Benninga. That will give you a start.
stylemog Wrote: ------------------------------------------------------- > bloomberg and factset have historical pro-forma > statements, but the main purpose of financial > models isn’t to record the past, it’s to show you > what could happen in the future. > > to my knowledge bloomberg and factset don’t have > working models that allow you to plug in > drivers/inputs to forecast future earnings and > cashflow. i wouldn’t be surprised if they had this > one day though… You are right that even though tools can provide historical data, doing it yourself (and reading 10Q and 10K, while you do that) will give you an idea about company & its recent past that you cannot get by simply using someone’s else financial model.
BigBean wrote: “Maybe this is the future, but for now there doesn’t seem to be the expertise, though I know a London based company that is aiming to tap into this market. I tried to convince my old company to let me start up the Indian side, but they were too old school for this.” This is already happening Goldman, Fidelity, JP Morgan, HSBC have all outsourced modelling work to India. Some small firms are starting to do this as well.
Good assumptions about a potential investment drive the financial model, not the other way around. Usually, good analysts have a gut feeling about a potential investment based on their fundamentals in advance of putting a model together. A careful analysis of a company’s fundamentals identify whether a business is a good investment; the model answers the question of how much you should pay for it. That being said, the model is still absolutely essential in order to pinpoint valuation.
Batterinram is correct. All the companies mentioned by him have outsourced their modeling work to India. Most of them have their captive centers and hire graduates and postgraduates (even CFAs and CAs) to do the work. Some of the BBs already having an operational center in India are JPM, Lehman, GS, HSBC, Fidelity, UBS, MS, Bank of America, Citi; even some hedge funds like DE Shaw have their captives in India. Apart from these, many more banks work with the third party outsourcing companies based in India, China, Latin America and CEE for their modeling and research work. I am workign at one of the third party outsourcing firms. The cost arbitrage is a major driver for outsourcing industry and the BBs are the ones taking maximum advantage. Outsourcing began with Business Process Outsourcing (customer care) and IT Outsourcing services and now it has moved to knowledge process outsourcing which includes outsource of services like market study, feasibility study (for companies and markets), financial models etc. Even many of the consultancy firms are outsourcing such work. This is a big market now. And due to the credit crunch most of the firms are opting for outsourcing as in order to achieve cost cutting.
batterinram Wrote: ------------------------------------------------------- > BigBean wrote: > “Maybe this is the future, but for now there > doesn’t seem to be the expertise, though I know a > London based company that is aiming to tap into > this market. I tried to convince my old company to > let me start up the Indian side, but they were too > old school for this.” > > This is already happening Goldman, Fidelity, JP > Morgan, HSBC have all outsourced modelling work to > India. Some small firms are starting to do this as > well. I guess it depends on the industry you work in. In my industry it is yet to happen - which is not to say it won’t.
numi Wrote: ------------------------------------------------------- > Good assumptions about a potential investment > drive the financial model, not the other way > around. Usually, good analysts have a gut feeling > about a potential investment based on their > fundamentals in advance of putting a model > together. A careful analysis of a company’s > fundamentals identify whether a business is a good > investment; the model answers the question of how > much you should pay for it. That being said, the > model is still absolutely essential in order to > pinpoint valuation. Numi: If you have time, can you please walk us through your approach in building a model for a company? That shall be much appreciated. Also, now that you are in PE, do you find a huge difference in modeling between research and PE?
Work that requires good IP protection is less likely to be outsourced, although it still could go to Canada or Ireland, as opposed to India and China.
gauravku Wrote: ------------------------------------------------------- > Batterinram is correct. All the companies > mentioned by him have outsourced their modeling > work to India. Most of them have their captive > centers and hire graduates and postgraduates (even > CFAs and CAs) to do the work. > > Some of the BBs already having an operational > center in India are JPM, Lehman, GS, HSBC, > Fidelity, UBS, MS, Bank of America, Citi; even > some hedge funds like DE Shaw have their captives > in India. > > Apart from these, many more banks work with the > third party outsourcing companies based in India, > China, Latin America and CEE for their modeling > and research work. I am workign at one of the > third party outsourcing firms. > Can you please go into more detail about the extent of your modeling responsibilities, and what you guys actually do as “outsourced modelers”? I have actually worked at not one, but two of the companies you mentioned above – and at least in my personal experiences, I felt that the modeling we outsourced overseas tended to be more mechanical in nature, i.e. setting up a model template, populating it with data from 10-Q and 10-K, and so forth. And while our counterparts overseas did a good job in this area, we (the analysts and associates in the US) typically retained responsibility for building the projections. In case you’re wondering why this is so, it’s because we – the analysts and associates in the US – are in the flow of information every day by being at work when the markets are open and constantly speaking with the traders, salespeople, and buy-siders. And what that means is that since we’re in the live loop of the markets the way that the folks overseas are not, it’d be easier for us to maintain and revise the projection assumptions ourselves, rather than having to communicate these assumptions overseas and having our peers there do it. Furthermore, and perhaps more importantly, we understood the companies far better than what our “outsourced modelers” did, and at the end of the day, it’s the assumptions and knowledge of a company’s fundamentals that drive the model, not the other way around. Anyway, I’d appreciate if you can clarify the scope of responsibilities that outsourced modeling entails. I think a lot of us have divided opinions as to what modeling really is – in my view, just setting up a model and pulling historical information is not modeling, whereas building the forward looking projections is. And it’s far more sensible for someone based in the US to do the latter, especially if we’re talking about a company in the US market, simply because they actually have the necessary sector knowledge to do so. If you guys can be more specific about what is being done overseas versus what is retained in the US, this could make for a more interesting discussion as opposed to just debating whether or not more finance work is being sent overseas (with the short answer to this question obviously being “yes”).
abacus Wrote: ------------------------------------------------------- > Numi: If you have time, can you please walk us > through your approach in building a model for a > company? That shall be much appreciated. Also, now > that you are in PE, do you find a huge difference > in modeling between research and PE? The best way to think about PE modeling is basically a combination of research and banking modeling. In research, you have primarily operating models – basically models that focus principally on the P&L, balance sheet, and cash flow, and building a financial representation of a company’s operations with as much granularity as is sensible. The idea of valuing a public security is essentially based on trading multiples, or a discounted valuation on its projected future cash flows. Research models don’t typically include assumptions about potential transactions, but they tend to be pretty detailed because the senior analyst is very knowledgeable about a sector in the way that the average banker isn’t, simply because that’s his or her specialty. On the banking side, you definitely look at a company’s operations as well – how you value a company doesn’t fundamentally change at all – but building up the different revenue and expense items is often less precise, and in fact, many bankers just get the operating projections from research reports anyway. Where the bankers come in is principally on the transaction side – their goal is to evaluate a wide range of potential transaction scenarios and sensitivities, and advise their client on the deal that makes not only the most sense for the management team’s objectives but to also garner the highest possible valuation for that entity, within reason. That’s the banker’s job – to help execute transactions, be it M&A, LBO, or whatever – and extract the most value they can so they get paid more. On the private equity side, I would say that having good transactional and research modeling skills are very important. It’s definitely more on the transaction side, particularly with LBO modeling, because we need to know what we are willing to pay for an entire company and also understand how IRR’s will change based on how much debt we can get or how we structure the transaction. But at the same time, because we’re on the buy-side (as opposed to the bankers who are on the sell-side), we are not looking for the most “optimistic” valuation a company – we want the valuation that comes closest to reality based on what our assumptions are. Thus, when we are engaged in the bidding process for a particular company, the bankers and management team of a potential acquisition target give us access to the data room, which is an electronic file containing a number of internal documents about the entity – these may include customer lists, monthly P&L’s, internal memos and projections, and so forth – basically all types of information that would not be available to the public. It’s amazing how little information is actually available to public investors till you’ve seen the private side. But the point is, since PE investors are in the business of buying companies, we basically want to know every little thing about a company and be able to anticipate every possible scenario or risk that can potentially affect the company. As a result, we not only care about building a thorough transactional model since that is what gives us an idea of how to structure the deal – but we certainly care about building a thorough operating model too, in order to best assess how the company will perform. And that’s where I personally feel my research modeling skills have come into play (not to mention that my research skills were far more developed than my M&A and LBO modeling skills, naturally because I came from the research side). Anyway, I guess this response is more detailed than I imagined it to be, but your question was a good one and one that was also raised by others in the past. Hopefully this helps.
Numi, that’s very enlightening. But I’m still a little foggy on how “transactional” modeling differs from “operational” modeling. Is it that you’re making a decision about whether to do pure equity, convertible debt, etc., and so you are running a number of future scenarios to figure out which has the best risk/reward? Or is it something else.
An operating model is primarily just forward projection’s about a company’s operating activities, i.e. income statement, balance sheet, and cash flow. It’s the type of thing that most CFA candidates/charterholders seem to be concerned about as public security analysts. Transaction models are M&A, LBO, restructuring, etc. There are a whole variety of considerations that go into a particular transaction, but the idea is to get the highest reward while managing potential deal-related risks.
First of all, thanks a lot for the explanation Numi. Such thorough discussions helps one to know about the kind of work performed at PE firms. As far as the explantion of kind of outsourcing work goes, you are very correct in your judgement and reasons. Almost, 75% of the work outsourced is about building models on the basis of historical data. The reasons provided by you are also very justified and practical. The analyst and associates based in the US have better idea about the markets there and are in a better position to take the best decission. However, in many cases (which are not exactly are the ones which involves buying and selling securities, rather than are deals which take time to settle), the client works with the support team in India to freeze the assumptions and decide the final results. This provides some exposure to the analysts based in the outsourcing location. And as far as the IP infringement issues are concerned, most of the outsourcing firms have NDAs with their clients and they also have a number of certifications for privacy issues. Also, many outsourcing firms also have IP division, so its highly critical for them follow such norms. Numi, I just wanted ask a question in general. I have got exposure to modeling and am quite efficient with it, however, for making a switch to a ER, PE or I bank, is it good to have certifications like what Wallstreetprep offers on the CV? I am a level II candidate (appeared for the same in June), so I am aware of the theoritical concepts associated with various models, however, don’t have hands on experience with many models. Though have experience of developing some of the models. Thanks again for the explanation and thanks in advance if you could spare some time and answer some of the queries I have.