Mastering Investment Banking (IBD) Jargon for Interviews

Hello and welcome back to The Deal Room. I hope everyone is doing well. New week, fresh start. And if you're in the application season, we've got another one that's going to be specifically targeted for you. And this one is simplifying IBD jargon. And I definitely can sympathise with this, not so much on IBD, but I've interviewed, I would say, at least 100 analysts in my day. And the jargon one is, uh, I guess a risk factor for some students who want to sound clever, but can very quickly come undone. And so Stephen, what I loved, what you sent me across here for a point of discussion is counting down the top 10 across technical, deal strategy, and industry terms, and then how best to describe them. So yeah, looking forward to this one, Stephen.

Yeah, I am too. I think it is, it's such an important one. And I do remember when I first joined, first joined the bank, uh, using these terms without really understanding them. And you always, you know, your palms get a little sweatier when you're trying to sound clever and you're using these terms and you're really hoping that someone doesn't ask that next layer of question. But why are you using this one? Why are you using this? And, and suddenly your level of knowledge turns out to be quite superficial. So yeah, I think one of the, one of the problems that we have in our industry is that we assume that people know these phrases and these terms, and then we just talk as if everyone already knows it. And sometimes you can just get lost with a sea of jargon. And hopefully this episode will help you feel a little bit more comfortable using these terms in an interview environment and having that next level of knowledge to make sure that you can follow it up and back it up.

Okay. And before we start talking about EBITDA and DCF and WACC and all these kind of these word structures, am I right in thinking you definitely don't need to be a finance econ student to learn this stuff, right?

Yeah, not at all. Again, these are not extremely difficult concepts if we can teach them in a way that passes the mum test, that passes the, you know, the person on the street test. And that's obviously quite a lot of what we try and do at Amplify. You know, I didn't come from a finance background. And eventually, with a decent amount of learning, I managed to understand these terms and get relatively intimate with them.

All right. Well, with that then, let's, let's dive in. What's, what's at number 10?

All right. Number 10. And again, this is not a 10th to first in importance because all of these are important bits of jargon, but we're just going to count down anyway. The first one that I want to talk about is EBITDA. Now a lot of you might go, pfft, I know what EBITDA is. It's earnings before interest, tax, and depreciation and amortisation. And yeah, this is pretty obvious to me, but EBITDA is a core representation of the profitability of a company such that you can compare the profit of one company with another. So when you are reading headlines and when you're looking at analysis, a lot of the metrics and the multiples that we use, use this term EBITDA. So why do we use EBITDA, Earnings Before Interest, Tax, Depreciation, Amortization, instead of something like operating profits or gross profits or net profits when analysing the profitability of a particular company. Again, this is assumed knowledge that we use EBITDA, but it's a little bit more complicated than that. So what— so why is EBITDA so good? So let's think about this. What we really, really want to understand about a company is how profitable it is relative to previous years, relative to other companies, and so that we can do stuff like profit margins. How efficiently does a company turn a dollar of revenue into cents of profit, right? And this metric, EBITDA, what it does is it strips out everything that is either not specifically related to the profitability of the company or maybe related to things that are outside of the company's control. So, think about the construct of the phrase: earnings before interest, tax, depreciation, and amortisation. So, you're stripping out interest. So, you're saying, I'm looking at this company's profit before the effects of interest. That's really useful because companies have different levels of debt and they pay different levels of interest. And those levels of interest might rise or fall depending on the interest rate environment of the country. and we don't really want that as part of our core analysis of core profit. So strip out interest. We strip out tax because companies exist in different countries and they have different methods of paying or deferring or treating tax. And we want to make sure that things that are maybe beyond the control or part of a separate element of analysis are just taken out of this core earnings. So earnings before interest, and tax. The last thing that we want to take out, and that's— this is where it gets a little bit confusing, is depreciation and amortisation. So depreciation, amortisation, they're taken together, and it's basically when you use an asset every day, you use an asset, you use a piece of machinery, that piece of machinery becomes less valuable as you use it. and every year if you have a piece of machinery that's worth £1 million and then the next year you, you use it all year and then it becomes worth £800,000 if you try to sell it, that's £200,000 of depreciation. Amortisation is exactly the same but for intangible things like intellectual property, patents, etc. So again, different companies have different ways of treating depreciate and accounting for depreciation and amortisation. And sometimes companies have just gone on a massive property, plant and equipment, a PPE spend investment. And that might be a really good thing for a company, but, but we don't really want to know about the organisational investment structure, the asset base, the depreciation schedule of this particular company. All we want to know is its core profitability. So we're stripping out interest, we're stripping out tax, we're stripping out depreciation and amortisation to get that comparable core earnings. And that is why we use it so often in the world of M&A and the world of kind of multiples analysis, EV EBITDA instead of EV net profit.

Yeah, it's a really, really great and clear explanation, even for someone like me to understand. So you're definitely hitting the, hitting the right marks. One question though was if you were asked in an interview just to explain what is EBITDA, then what's the normal timeframe? So yours was more like a, this is what it is and it's a teaching to learn, but in an interview scenario, is it like you've got 30 seconds to wrap up that summary? What does that actually look like?

It's a really good one. And I think the key is to be as succinct as possible, because if the interviewer wants to learn more, they will ask you to dive a little bit deeper. So if I, if someone asked me, hey, you know, Stephen, what is EBITDA? I would say, look, this is, it's a really, really useful core measure of profitability that strips out items that are related to the company's capital structure or are beyond the company's control so that we can really use this metric for comparability. Do that, and then they can dive deeper if they want.

Okay. So Stephen, I'd like you to tell me about leverage.

Yeah. So leverage is number 2. And again, this is a concept that everyone assumes that people know a lot about. And it's one of those annoying jargony words, because leverage just means debt, right? And leverage is, again, it's such an important element of analysing, analysing deals, especially in the context of a leveraged buyout transaction where a private equity firm is buying an entire company using a combination of equity and debt. And then you have phrases like This company has got a highly levered or highly leveraged capital structure. What does that mean? Well, it basically means the company's got a lot of debt relative to the equity that it's got in the company. You can fund a business using debt and you can fund a business using equity. So the more highly levered a business is, the more debt it's taken out relative to the equity that it's raised. And remember, as we kind of go into that next level of detail, There are benefits to having a relatively highly levered capital structure. The more debt you have relative to equity, the smaller the slices of pie, the equity pie that you're having to give out to other investors to fund your business. Remember debt investors, well, they only want to get paid back and to receive interest. That's all they care about. So it's not a bad thing. Cost of capital or the cost of debt might well be cheaper in some circumstances. But obviously there are massive risks to being overly levered, having to pay too much interest on your debt such that you end up with no free cash flow. If the value of the business drops and you're left with this massive pool of debt, that's when bankruptcy comes into it. So yeah, so leverage, very, very important context, especially in the context of a leveraged buyout model or a highly leveraged capital structure.

So just continuing our kind of fictitious role play, who, Stephen, would be an example of a highly levered company?

It's a really good question. So any, almost every company that is owned by a private equity buyout firm would have a highly leveraged structure. And the way that we look at leverage is we use leverage ratios. So you can look at total debt divided by EBITDA, back to number one. So if the total debt of a business is over 4 times its annual EBITDA, its annual profit, that is considered to be getting towards being highly leveraged and getting towards the areas of lending that aren't traditional. You know, normal banks are not usually going to lend at that level of leverage, you start getting into different cap— different lending products, different types of investors, etc., etc.

Okay, cool. Good stuff. Well, let's move on because I know we've got 3 more in this bucket of more technical terms. So DCF.

Okay. DCF, the discounted cash flow. I love this because in technical interviews, in M&A, someone will ask you to walk me through a DCF or tell me what a DCF does. And you need to have a really good answer because this is what, this is something that's going to come up. And I like thinking about it from the very, very basic facts of finance. So the atomic principle of discounted cash flow is that money received today is worth more to me than some speculative money potentially received in a few years' time. And the analogy that I like to use, Ant, is let's say I lent you £100 and I said, well, you said, look, I can pay you, I can pay you back tomorrow, or I can pay you back in 3 years' time. What would you rather have? Well, of course I'd rather you pay me back tomorrow. Because, you know, then I know that I'm getting the money. I can use that money to invest or do a load of fun stuff with it. And who knows in 3 years' time whether you'll be bankrupt, whether I'll know you, and obviously the effects of inflation will make that £100 a lot less valuable. If you turned around to me and said, hey, Stephen, I can give you £100 tomorrow, or I can give you £180 in 3 years' time, then I start getting interested. I start thinking, all right, is £180 in 3 years' time worth more to me than £100 today? And that is when I start to think about discounting that future free cash flow back to today. And I will go through my discounted cash flow calculation to discount £180 in 3 years' time back to see how much that is worth to me today. So the discounted cash flow, it is the present value of a company's future free cash flows discounted using a thing called the discount rate based on the principle that money today is worth more to me than some money at some point in the future.

So is, is there a, you said that this one is definitely going to come up in an interview. So what is it that you specifically would want to hear as like the perfect answer? Yeah.

So there's, there'll be two questions. One will be, you know, what is a DCF? Why is it important? Another will be walk me through a DCF. And let's take the, let's take the former. I think that first explanation is a, is a reasonably strong one. And then you would probably want to go into one more level of detail. And this is number 4 in my jargon buster. So a discounted cash flow, it relies upon a bunch of inputs, right? The first input is we need to relatively accurately project the company's future free cash flows. That's part of financial modeling. And the second is we need to appropriately discount those future free cash flows using a discount rate. And we use in this instance, a thing called the weighted average cost of capital. Now to go back to my analogy, lending you money, Ant. So, if I was thinking about that £180 in 3 years' time versus £100 today, what I would need to do is I would need to apply a discount rate based on how risky you are as a person, right? So, I might think, okay, I know Ant pretty well, you know, he's got a decent stable job. Yeah, I'm going to apply a certain discount rate. Right? If maybe it was my parents, maybe the discount rate would be lower because they're slightly safer. I know I'm going to know my parents in 3 years' time. If it's some mate that you know never pays money back, your discount rate's going to be much, much higher, and therefore you have to discount that £180 by a lot more. And the weighted average cost of capital is exactly that, but for companies. So the weighted average cost of capital Basically is how much, how much do I need to be compensated for lending to or investing in that particular company? So the weighted average cost of capital for the likes of Apple, it's going to be extremely low because we don't need to be compensated that highly for the risk associated with Apple, but the weighted average cost of capital for an early-stage startup is going to be extremely high because we don't really know whether we're going to get that money back in the future. So this weighted average cost of capital, the discount rate applied to future free cash flows, is basically a representation of the risk of that company and a risk of you not actually getting to see those free cash flows in the future. The higher the discount rate, the more we have to discount those free cash flows in the future because the less certain we are that those free cash flows will actually happen. So if you can talk about that combination of a DCF and then the key assumption of the weighted average cost of capital as a proxy for the risk of a company, you're starting to get into good foundational understanding of this valuation method.

Quick question to wrap that up. I know in markets, when I talk to someone about markets and particularly quoting prices, and products, the way they actually say it, like the nuance of quoting a product like 114 and a quarter or trading a half a tick or a yard. So when someone's mentioning these, is it, and again, I'm playing completely naive here, is it best protocol to say discounted cash flow or DCF, or does it matter?

I don't think it really matters. I would always think about the way that you would write it in a structured piece of work. I would always start by saying discounted cash flow, then go on and talk about DCF just so that people know that this is the thing and you know what you're talking about. Same with weighted average cost of capital. EBITDA, probably the same as well. I'd go EBITDA, you know, obviously this is earnings before interest, tax, depreciation, amortization. I wouldn't keep saying that all the way through.

Makes sense. All right, the last one here in the technical terms does make me— does bring a smile to my face because it's what I hear when comedies, uh, comedians are talking about finance people. And I've got— and I am stood here on this podcast with a headset on and I'm about to say the word synergies. So, uh, talk to me about synergies.

Oh, synergies. Yeah, synergistic. What a horrible word that is. Yeah, the synergies. I mean, it is one of those brilliant corporate jargon bits. And for, from a, from an investment banking perspective, it has a very specific use case. So synergies, I always just think about it as benefits, right? Synergies are benefits. Let's just be totally honest. So when we are thinking about a modelling in acquisition, so one company buying another company, what you need to do as an investment banker is you need to think about the potential benefits that are occurring as a result of that acquisition happening. Now, those benefits or synergies can be cost benefits. So, it stands to reason, one would hope, that one company acquiring another company, there might be some cost efficiencies that you can gain. So, you know, merging head offices, cutting down on some manufacturing bases, improving the efficiency of transportation, whatever it might be, there will be cost benefits to model, and there also might be revenue benefits, revenue synergies. So these revenue synergies might be the bundling of goods together, the bundling of products together in order to make your product more attractive to the client. This often happens in SaaS and in technology. Now, one thing to note on synergies, also known as benefits, is there is another side to this coin when it comes to M&A modelling. And that's integration costs. So we're really excited as M&A bankers about synergies or benefits because they are items within our financial model that can help juice the valuation, right? If we can achieve $200 million of cost synergies, we can probably afford to pay a little bit more for this company. But what we often forget to, uh, to model appropriately is the vast integration costs of meshing two companies with different systems, languages, and cultures. Together. So synergies, also known as benefits, always remember the flip sides from an M&A perspective, which are integration costs.

All right, well, look, that takes us on to the conclusion of that first category. The next two categories are strategy and then some terminology around the wider industry. So let's, let's go with strategy first because I know you have three in this area.

Yeah, and again, in terms of an interview question, you might be given a case study Uh, or you might be asked to talk about a deal. And we need to remember that we all, what we are talking about when we're talking about acquisitions, people do, companies do acquisitions in order to become more profitable and in order to boost their profitability. And we'll talk about that in a second, but there are a number of strategies and tactics to achieve that increase in profitability. And the first bit of jargon that I want to talk about is vertical versus horizontal. So a vertical merger or a vertical acquisition, what does this mean? So again, the best example that I use for vertical M&A is the oil and gas space. So to be vertically integrated means that you have Bought companies and integrated those companies at various different stages of the value creation chain within that particular segment. So oil and gas, Chevron, Exxon, BP, Shell, these are vertically integrated oil and gas majors. And this means that they own the business unit that explores, finds oil, the business unit that extracts the oil, the business unit that transports the oil, the business unit that refines the oil, the business unit that delivers the oil, and then the point of sale business unit. Oh yeah. And also the trading element as well. So they are vertically integrated and there are lots of good reasons to be vertically integrated. You get to achieve, you get to take margin, profit margin at every level. You get some certainty through the supply chain. Not every business, not every business strategy lends itself to vertical integration, by the way. And the opposite is horizontal integration. And that is much more straightforward. That is me buying a company within my market space, within that rung on the kind of supply chain, such that I can benefit from economies of scale and things like that. Think of a SaaS technology provider buying another SaaS technology provider in order to bundle the goods together and achieve a little bit of advantages through market share and scale. So you've got vertical integration and then you've got horizontal integration. We have many more horizontally integrated M&A deals than we do vertical. So most of the time you'll be talking about, in an interview, you'll be talking about horizontal integration.

Yeah, I was going to ask that actually. So depending, because I know we're going to talk about sector teams in a while, but I guess there's some sector relation when coming to oil and gas and so on. But look, we'll park that for now. Let's stick with the strategy terminology. So vertical versus horizontal. Next one that you've got here is accretion versus dilution. So what's that?

Accretion versus dilution. Accretion is another one of those absolutely well-used, overused M&A jargon terms, and one that you need to make sure that you are using in the right context. 'Cause it, I've, I've heard people just use it because they think it's the right word to use, but it's, it's not always the right word to use. To take my previous point, in the world of M&A, what do companies want, right? They want to become more profitable. M&A is one of the strategies to employ to increase your profitability, right? That's— companies just have a natural goal to become bigger and more profitable. That's just the nature of a company. It's the way that companies work. It's the way that shareholders want companies to work. So, accretion, what we're talking about with regards to accretion in the context of mergers and acquisitions is if I buy another company, Is this company, is this acquisition going to be accretive or going to improve my earnings per share? Now, if you think about earnings per share, that is my profitability per unit of share, right? Per share. So what I am trying to figure out is whether an acquisition, whether the earnings i.e., the new profit that is brought on through this acquisition and through synergies outweighs the increase in capital that I've employed to finance this transaction. It's a simple, you know, so earnings is the numerator, the top of a division, and cost of finance. Oh, so the capital is the denominator. The per share. So you want earnings to outstrip the dilutive nature of financing this transaction. Earnings per share accretive acquisitions are really, really well liked in the market because earnings per share is such a key element of analyzing the profitability and the success of companies. And obviously accretive transactions, it can be achieved because you've bought an undervalued asset, you've actually managed to achieve a lot of synergies. But the flip side is dilutive. So a lot of acquisitions, especially in the short term, are earnings per share dilutive. Just think about buying a company because you really, really like its technology and some of its members of staff. If the company is loss-making, you're effectively not adding, if anything, you're taking away from your earnings. The numerator, the top of the equation, but you're still diluting your share base because you've had to finance the transaction. You would hope that even though an acquisition like that is dilutive in the short term, it might well be accretive in the long term because you've acquired this technology that's going to power future growth and future increase in your earnings per share. So accretion versus dilution, it is the kind of key marker of whether we believe, when we're modelling M&A, whether we believe an acquisition is likely to be successful, accretive, or unsuccessful, dilutive.

Quick question. If I was a banker working on a dilutive deal, is my job somewhat to then engineer the vision to articulate to the analysts on the street manage then that in terms of a share price reaction? I'm just thinking from a trader's perspective.

Yeah, you would say, you would say if it's a technology transaction or something that is strategic in the longer term, you would say this acquisition is expected to be earnings per share accretive by year 3. That's the way that you would do it. You would model it out into the future, and that would be the target that would make investors feel a little bit more comfort when it comes to that kind of guidance.

Yep, makes a lot of sense. All right, we're into the final segment, so wider industry. And here, just to give you a flavor, we've got bulge brackets versus boutiques, and then sector coverage versus product specialists. So perhaps then this word bulge bracket— I'm actually quite sure that there's a lot of students, perhaps even more than there is less, who are applying to bulge brackets and don't even know what bulge bracket stands for, never mind some of the technical terms you've described.

Yeah. Again, this is one of those ones that we hear a lot, you know, should I be applying for a BB versus an EB and, and, and people banding around bulge bracket versus elite boutique and versus boutique without really knowing what that means. And I, bulge bracket is a very strange term and what it actually means in its, in its most kind of basic essence, bulge bracket means you're, you have got a bigger font size on an IPO or debt prospectus. So if you look at an IPO prospectus, an S-1 filing, you will see all the different banks that have been supporting, and the lead banks have got the biggest fonts. They are in the bulge bracket of that front page. That's what it means. But what it actually means in reality is there are a group, a very select group of banks that have full franchise IBD divisions that cover both advisory and capital raising. So they are high-quality top 10 players, both in equity capital markets and debt capital markets, and in M&A and restructuring, and also have the kind of global presence that means that they can basically say yes to any transaction and believe that they've got the capability to do so. So The flagship bulge brackets are Bank of America, Barclays, although their star is slightly falling, Goldman Sachs, JP Morgan, Morgan Stanley, UBS. There's a little bit of debate as Deutsche used to be, but its revenues have been dropping. Is that still a bulge bracket bank? RBC and Jefferies and Wells Fargo, they're starting to really climb the leaderboards, but they're not necessarily quite there yet. But again, a Morgan Stanley, a JP Morgan, a Goldman Sachs, a UBS, Bank of America, you're pretty safe to say that these guys can do anything and therefore they're bulge bracket.

In terms of, is there a bit of a jack of all trades, master of none in terms of if I was say, I think I remember years ago I went to the Houlihan Lokey office and I was doing a bit of research because, you know, I'm from a market side and I wasn't talking about banking there to talk about other careers-related topics, and I saw that they were number one, but in restructuring specifically. So is it the fact that you, with all these different categories of that you could work in within banking, there's actually, if you can define that area, you don't necessarily have to go to a bulge bracket? Or is the upside the bulge bracket has very matured, uh, structural training that you receive traditionally, and that's why you'd go there first?

Or Yeah, from a, from a career perspective, it's, it does, there is some benefit from being part of a bulge bracket because just imagine you are doing a pitch to a potential client or, or an existing client and the pitch is, all right, we want to, we want you to consider doing some M&A to doing some, doing some kind of acquisition and you will be able to bring in 4 or 5 different teams. From within your bank to contribute to that pitch. You can bring in your TCM guys, your ECM guys, your syndicated finance guys, maybe your leverage finance guys. You'd have sector coverage team, and then you'd have the M&A team. You might be working internationally with some potential international targets. And as an analyst, you're just getting to see just so many different divisions, whereas with an elite boutique, that focuses more on advisory. So again, restructuring or M&A. So these are the likes of Centerview and Evercore and Lazard and Mollis and Rothschilds. You're going to become extremely good at a narrower number of different products within IBD, and you're going to get extremely good training, but maybe you won't see maybe so many of the international deals or the multiple different capital markets products deals, and you might just not get that variety of experience. By the way, as with any business, as we've discussed before, businesses trend towards getting bigger. So the likes of Evercore and Mollis and Rothschilds that started out as pure play advisors, they are now very quickly expanding into private markets advisory, uh, capital markets advisory, and they are starting to look like full-service investment banks just without maybe the international presence and without the massive balance sheet that comes with some of the Bank of Americas of this world.

Okay, cool. This takes us to our, our last one then, and this is one when, you know, superficially when I have probed students and they're like, yeah, I don't want to work in trading or asset management. I want to work in banking. And then you say, what specific area of banking? And you lose a couple people here who don't understand the differences of the different sectors in themselves, but as I'm sure you're going to explain, also the product specialists as well. So can you shed a bit more light on these two terminology points?

Yeah. So we have sector coverage versus product specialists as our, as our last point. And I think it's really important in the context of an interview for you to have a good answer to the question, all right, where would you like to be? You know, IBD is a big thing. What, what do you want to be doing? Because often it's an internship interview or you will not know exactly what part of the IBD that you're going to be in. So it's really, really useful for you to A, know what the difference is and B, have a decent answer. So you've got product specialists. So if I work in M&A, that's a product. If I work in equity capital markets or debt capital markets, those are products and you become a product specialist and you get brought into meetings and then deals based on your product expertise and the need for that product expertise. The flip side, the other side of the engine is sector coverage. And these are product generalists or product agnostic sector specialists. So these are the people, these are the desks that have the really strong relationships with the major players within that particular sector and also have a really good finger on the pulse of the trends within that sector so that they can originate a meeting within a, with a particular client that they know discussing a particular trend that might result in some fee-based revenue for the business. So the sector teams, I mean, it depends what bank you're in, but think about them as things like real estate and healthcare, Technology, media, and telecoms. Now technology tends to be split out. Financial institutions group, industrials, oil and gas, metals and mining, food and beverage, and things like that. Really, really good to have an answer to the question, where would you like to be? What really interests you? And it might be that you say, look, I'm really interested, you know, I just love transactions. Like I love doing deals and I love the mechanics of M&A and I just really want to be doing as many deals as possible because that's going to build the experience that I think that I want to get. That's a great answer. You might also want to say, you know, for the last 5 or 6 years, I've, I've just been totally obsessed with healthcare companies. And I did a case study, you know, with my banking society at university and we looked at a pharmaceutical company and I was really interested in, in patent protection and the life cycle of drugs. And I think that we as the healthcare team have a really important role to play in the future of these big companies. Either answer is fine, but just make sure that you know that there are spaces to navigate within IBD and just make sure that you have a decent answer.

Yeah, I've always quite liked the latter when someone has a genuine, authentic interest in the subject matter. They are so much more convincing in that way, I've always found. So yeah, definitely I'd lean into that. Well, look, that was fantastic. I think that's actually up there, one of my favourite episodes, because I feel like you're such a great teacher and how you break it all down. Um, you know, I wish I had that when I was at school. So hopefully everyone else found it equally as useful. My final request to Stephen is It's coming up, you know, it's a fresh week. I could do with an extra 100 quid. I'll pay you back on Friday if that's okay.

Yeah, yeah, you can pay me back 110 quid on Friday. I've done some mental maths and I think that's probably the discount rate that I would apply to you, Ant.

All right, well, that's it for this week. We'll see you next time and thank you, Stephen.

Thank you, Ant.