Blackstone Interview Prep

Could a company have a negative book Equity Value?

Yes, a company could have a negative book Equity Value if the owners are taking out large cash dividends or if the company has been operating for a long time at a net loss, both of which reduce shareholders' equity.

What is a beta (B)?

- The volatility or riskiness of an investment relative to the market

What is working capital?

Current assets - Current liabilities

What does BAAM do?

- Provide access to alternative investment strategies through portfolio hedge funds, registered liquid funds, direct investing, manager seeding, and general partner ownership - is a FOF

What are the two structures of hedge funds?

Master Feeder and Side by Side

Registered Funds

- Deliver institutional caliber investment exposures to individuals and their financial advisors in easily accessible, registered funds that employ the same disciplined process and utilize the same experienced team that has long served our institutional clients. Our liquid, open-end and closed-end funds provide access to some of our largest manager relationships.

Closed End Fund

- Portfolio of pooled assets that raises a fixed amount of capital through an IPO and then lists shares for trade on a stock exchange. - Offer higher returns or better income streams than Open End Funds

Cash from Operations

- Cash generated or lost through normal operations, sales, and changes in working capital

What offers better returns, Open End or Closed End Funds?

- Closed End Funds offer higher returns because the higher risk involved with investing in illiquid securities could translate into higher returns for shareholders

What happens on the income statement if inventory goes up by $10?

Nothing - the only impact will be on the balance sheet and the cash flow statement.

When do you capitalize rather than expense a purchase?

If the purchase will be used in the business for more than one year, it is capitalized and depreciated.

Income Statement

- A financial statement showing the revenue and expenses for a fiscal period. - Revenues - COGS - Expense = Net Income

Balance Sheet

- A financial statement that reports assets, liabilities, and owner's equity on a specific date. - Assets = Liabilities + Shareholders' Equity

Cash Flow Statement

- A financial statement that shows the flow of money in and out of the business. It shows the company's sources and uses of cash. - Beginning Cash + CF from Operations + CF from Investing + CF from Financing = Ending Cash

Limited Partnership (LP)

- A partnership consisting of one or more general partners and one or more limited partners. - Must have at least one general partner, who has decision-making authority and unlimited liability, and any number of limited partners, with no decision-making authority and whose liability is generally limited to the amount of their investment

Collateralized Debt Obligation ("CDO")

- A type of security that pools together a number of interest paying assets, and pays "coupon payments" based on those assets' future cash flows

What questions would you ask a hedge fund manager?

- About past experience - His/her investment strategy & how has it changed - Vision for the future

Hedge Fund

- Alternative investments using pooled funds that employ different strategies to earn active returns, or alpha, for their investors - Most often set up as private investment limited partnerships that are open to a limited number of accredited investors and require a large initial minimum investment - Require less SEC regulations - Hedge Fund can invest in anything - real estate, stocks, derivatives, and currencies

Hedge Fund Portfolio Solutions

- Build customized portfolio solutions of alternative investment strategies. As a market leader in hedge fund solutions, we have built lasting and valuable partnerships with underlying managers. Our rigorous process for evaluating managers and opportunities is critical to our success.

What does investing through a portfolio of hedge funds mean?

- Build customized portfolios of alternative investment strategies

What are operational due diligence framework style buckets?

- Dedicated - Shared - Modular - Hybrid

Special Situations

- Directly invest in special situations and other differentiated opportunities that we source through our vast network. The size and scale of our platform, combined with our relationships across the industry, give us access to interesting deal flow and idea generation. They also provide us with considerable resources to research and manufacture new exposures.

Open End Fund

- Diversified portfolio of pooled investor money that can issue an unlimited number of shares - The fund sponsor sells shares directly to investors and redeems them as well - Shares are priced daily based on their NAV

EBITDA

- Earnings Before Interest, Taxes, Depreciation, and Amortization - Metric used for evaluating a company's profitability - EBITDA = Revenues - Expenses (excluding interest, taxes, depreciation, and amortization)

Precedent Transactions

- First, find historical transactions similar to the transaction in question, including size of the company, industry, economic context, etc. - Once you have found one or more transactions, look at the valuation process. What metrics (EBIT, EBITDA, etc.) were used? Calculate a valuation multiple based on the sale price(s) in the precedent(s), and apply the multiple to the appropriate metric for the current company. - Most of the time this valuation technique will result in the highest valuation, due to the inclusion of a "control premium" a company will pay for the assumed synergies they expect to occur after the purchase

What is a direct investment?

- Foreign Direct Investment (FDI) is when investors put their money into a business operating in another country - They aim to get a strong voice in management of the enterprise and a long-term presence in a foreign country - Directly invest in special situations and other differentiated opportunities - Can occur organically or inorganically

What documents should you request from a hedge fund manager?

- Fund's pitch book, investment mandate, and performance track record

Value Creation Program

- Global Portfolio Operations - Strategic Advice - Product Development - LP Connectivity - Capital Allocations

What are the 4 strategies of BAAM?

- Hedge Fund Portfolio Solutions - Registered Funds - Special Situations - General Partnerships Stakes & Seeding

Seed Capital

- Initial capital required to start up a business - Early investment which is meant to support the business until it can generate cash of its own or gain further investments

What does registered liquid funds mean?

- Invests in security with residual maturity up to 91 days - Mutual Funds that predominantly invest in debt securities with short term maturities that yield fixed returns

What the most common hedge fund investment strategies?

- Long/Short Equity - Market Neutral - Merger Arbitrage - Convertible Arbitrage - Event-Driven - Credit - Fixed-Income Arbitrage - Global Macro - Short-Only - Quantitative

Strategic Capital Advisors

- Makes long term investments in the general partnerships and management companies of leading alternative asset management franchises

What are some valuation risks?

- Making sure all assets are fairly valued in accordance with US GAAP, make sure portfolio manager has nothing to do with valuation process

Liquid Alternative

- Mutual Funds or Exchange-Traded Funds that aim to provide investors with diversification and downside protection through exposure to alternative investment strategies - Bought and sold daily (liquid) - Make the strategies employed by hedge funds accessible to retail investors

What is Enterprise Value?

- the value of an entire firm, both debt and equity - Enterprise Value= Market Value of Equity+ Debt+Preferred Stocks+Minority Interest-Cash - price that would be paid for a company in the event of an acquisition

What does having negative net working capital mean?

- Negative working capital is common in some industries such as grocery, retail, and the restaurant business. For a grocery store, customers pay upfront, inventory moves relatively quickly but suppliers often give 30 days (or more) credit. This means that the company receives cash from customers before it needs the cash to pay suppliers. Negative working capital is a sign of efficiency in businesses with low inventory and accounts receivable. In other industries, negative working capital may signal a company is facing financial trouble. - If working capital is temporarily negative, it typically indicates that the company may have incurred a large cash outlay or a substantial increase in its accounts payable as a result of a large purchase of products and services from its vendors.

How are the three main financial statements connected?

- Net income flows from the IS into cash flow from operations on the CF statement - Net income minus dividends is added to retained earnings from prior period's Balance Sheet to come up with retained earnings on the current period's Balance Sheet - Beginning Cash on the CF statement is cash from the prior period's Balance Sheet, and Ending Cash Balance on the CF statement is Cash on the current period's Balance Sheet

General Partnership (GP)

- Relationship in which all partners contribute to the day-to-day management of the business - Each General Partner has Decision-Making authority and unlimited liability - The liabilities, contributions, and responsibilities of the partners are often equal unless stated otherwise

What is Alpha?

- Return above the market for a given period - Refers to the excess returns earned on an investment above the benchmark return - Active portfolio managers seek to generate alpha in diversified portfolios, with diversification intended to eliminate unsystematic risk

General Partnership Stakes and Seeding

- Seek to partner with talented managers at all stages of their life cycles. We provide seed capital to emerging managers to help them grow and stabilize their businesses, and we acquires minority stakes in established managers, serving as a strategic partner to help them build enduring franchises.

What is the efficient market hypothesis?

- Share prices reflect all information and consistent alpha generation is impossible - Stocks trade at the fair market value on the exchanges, making it impossible for investors to purchase undervalued stocks or sell stocks for inflated prices

Operational Risk Factor

- Summarizes the chances and uncertainties a company faces in the course of conducting its daily business activities, procedures, and systems Ex) Maintenance of necessary systems and equipment, Compliance Processes, Valuation Techniques, IT Infrastructure, Business Continuity, Disaster Recovery Planning, Cash Management Controls

Market Valuation

- The market value of equity is used only for publicly traded companies. - It is calculated by multiplying the number of shares outstanding by the current stock price. (yield equity value of the firm)

What are the cons for Comps?

- The stock market doesn't have a fixed way of reacting. It reacts impulsively to the events or happenings in the market. So, it is very difficult to predict the reaction of the stock market on a given day. Thus, the factors you use may not help you at all. - A 100% comparison of one company with another is never possible. There will always be room for error. - The smallest companies have tiniest stocks. And these stocks may not always reflect the actual value of the company.

Mutual Funds

- Type of investment vehicle made up of a pool of money collected from many investors to invest in securities like stocks, bonds, money market instruments, and other assets - Operated by professional money managers, who allocate the fund's assets and attempt to produce capital gains or income for the fund's investors -MF Portfolio is structured and maintained to match the investment objectives stated in its prospectus

Exchange Traded Fund

- Type of security that tracks an index, sector, commodity, or other asset, but which can be purchased or sold on a stock exchange the same as a regular stock

Credit Default Swap ("CDS")

- Used as insurance for the buyer of a credit such as a bond or a loan in order to minimize risk, ensuring that the buyer will be repaid in a bankruptcy scenario - Can be purchased as a speculation tool

What are some business viability risks?

- Whether this solution also works for various aspects of our businesses - Inability to attract sufficient AUM to cover overhead, poor work culture

How do you calculate a firm's terminal value?

1. Perpetuity Growth Method - Choose a modest growth rate, usually just a bit higher than the inflation rate or GDP growth rate, and assume that the company can grow at this rate infinitely. You then multiply the FCF from the final year by 1 plus the growth rate, and divide that number by the discount rate (WACC) minus the assumed growth rate 2. Terminal Multiple Method - Choose an operation metric (most commonly EBITDA) and apply a comparable company's multiple to that number from the final year of projections

Walk me through a DCF

1. Project the companies free cash flows for about 5 years. Free cash flow is EBIT times 1 minus the tax rate plus depreciation and amortization, minus capital expenditures, minus the change in networking capital. 2. Predict free cash flows beyond 5 years using either a terminal value multiple or the perpetuity method. 3. To calculate perpetuity method, establish a terminal growth rate, usually about the rate of inflation or GDP growth, a low single digit percentage. 4. Now multiply the year 5 cash flow by 1 plus the growth rate and divide that by your discount rate (WACC) minus the growth rate. 5. Discount rate is the WACC, use that rate to discount all your cash flows back to year zero. The sum of the present values of all those cash flows is the estimated enterprise value of the firm according to the DCF.

What is the difference between accounts receivable and deferred revenue?

Accounts receivable is money a company has earned from delivery of goods or services but has not collected yet. Deferred revenue is the opposite, money that has not yet been recorded as revenue because it was collected for goods or services not yet delivered. Deferred revenue represents cash received from customers for services or goods not yet provided. Accounts receivable represents cash owing from customers for goods/services already provided.

How could a company have positive EBITDA and still go bankrupt?

Bankruptcy occurs when a company can't make its interest or debt payments. If a required interest payment exceeds a company's EBITDA, then if they have insufficient cash on hand, they would soon default on their debt and could eventually need bankruptcy protection.

If you could only use one financial statement to evaluate the financial state of a company, which would you choose?

Cash Flow Statement so that I could see the actual liquidity position of the business and how much cash it is using and generating. The IS can be misleading to any number of non-cash expenses that may not truly be affecting the overall business. The Balance Sheet alone just shows a snapshot of the Company at one point in time, without showing how operations are actually performing. The CF Statement shows whether a company has a healthy cash balance and generates significant cash flow which indicates that it is probably financially stable.

Cash from Financing

Cash generated or spent on financing the business; may include proceeds from debt or equity issuance (source of cash) or cost of debt or equity repurchase (use of cash).

Cash from Investing

Cash generated or spent on investing activities; may include, for example, capital expenditures (use of cash) or asset sales (source of cash). This section will also show any investments in the financial markets and operating subsidiaries. Note: This section can explain a large negative cash flow during the reporting period, which isn't necessarily a bad thing if it is due a large capital expenditure in preparation for future growth.

Why do you subtract cash from Enterprise Value?

Cash has already been accounted for within the market value of equity. You also subtract cash because it can be used to either pay a dividend or reduce debt.

Do you think hedge funds will generate lower or higher returns in the future? Why so?

Depends on the manager. It will be lower for managers that act like big indexers because alpha has been arbitraged out. But for a true "stock picker" or a manager that truly understands how to manage risk and return through stock or investment selection, will over time create real value of alpha for his clients, the trick is understanding what the manager does and finding a manager that can do it.

How do you calculate Free Cash Flow? (Unlevered)

EBIT(1-T) + D&A - CapEx - Changes in Net Working Capital

Would you be calculating Enterprise Value or Equity Value when using a multiple based on free cash flow or EBITDA?

EBITDA and free cash flow represent cash flows that are available to repay holders of a company's debt and equity, so a multiple based on one of those two metrics would describe the value of the firm to all investors. A multiple such as P/E ratio, based on earnings alone, represents the amount available to common shareholders after all expenses are paid, so if you used this multiple, you would be calculating the value of the firm's equity.

Why might there be multiple valuations of a single company?

Each method of valuation will generate a different value because it is based on different assumptions, different multiples, or different comparable companies and/or transactions. Generally, the precedent transaction method and DCF analysis lead to higher valuations than comparable companies analysis or market valuation. The precedent transaction result may be higher because the approach usually will include a "control premium" above the company's market value to entice shareholders to sell and will account for the "synergies" that are expected from the merger. The DCF approach normally produces higher valuations because analysts' projections and assumptions are usually somewhat optimistic.

What are some 3rd party related risks?

Ensured auditing by an accredited accounting firm

LBO Valuation

Essentially an LBO (leveraged buyout) is when a firm uses a higher than normal amount of debt to finance the purchase of a company, then uses the cash flows from the company to pay off the debt over time. Many times they use the assets of the company being acquired as collateral for the loan. When they are ready to sell the company, ideally the debt has been partially or fully paid off, and they can collect most of the profits from the sale as the sole equity owners of the company. Since a smaller equity check was needed up front due to the higher level of debt used to purchase the company, this can result in higher returns to the original investors than if they had paid for the company with all their own equity (ie without any debt).

What are three examples of common budgeting methods?

Examples of common budgeting methods include zero-based budgeting, incremental budgeting, and value-based budgeting.

Expensing vs capitalizing

Expensing vs. capitalizing refers to how a cost is treated on the financial statements. Expensing a cost indicates it is included on the income statement and subtracted from revenue to determine profit. Capitalizing indicates that the cost has been determined to be a capital expenditure and is accounted for on the balance sheet as an asset, with only the depreciation showing up on the income statement.

What happens to free cash flow if net working capital increases?

FCF will decrease; as more cash is tied up (either in accounts receivable, inventory, etc), FCF is reduced

How would you conduct due diligence on a hedge fund?

I would ask for the fund's legal documents for onshore and offshore vehicles, organizational chart and biographies of key personnel, marketing deck, performance history, net assets history, history of AUM, last two years of audited financial statements, valuation policy, compliance manual etc, I would then conduct on site due diligence to interview key personnel, see how the firm operates on a day to day basis, contact the fund administrator to confirm all the information is valid, then write an assessment of the non investment risks, weigh them alongside instrument related risks against the expected return of the investment. if the investor is willing to tolerate the risk, I would then invest

When would you not want to use a DCF?

If you have a company that has very unpredictable cash flows, then attempting to project those cash flows and create a DCF model would not be effective or accurate. In this situation you will most likely want to use a multiples or precedent transactions analysis. OR When debt and working capital serve a completely different role altogether. For example, DCF is not used to value banks as banks and financial institutions don't reinvest their debt and working capital.

If cash is collected from customers is not yet recorded as revenue, what happens to it?

It usually goes into "Deferred Revenue" on the balance sheet as a liability if the revenue has not been earned yet.

What, in your opinion, makes a good financial model?

It's important to have strong financial modeling principles. Wherever possible, model assumptions (inputs) should be in one place and distinctly colored (bank models typically use blue font for model inputs). Good Excel models also make it easy for users to understand how inputs are translated into outputs. Good models also include error checks to ensure the model is working correctly (e.g., the balance sheet balances, the cash flow calculations are correct, etc.). They contain enough detail, but not too much, and they have a dashboard that clearly displays the key outputs with charts and graphs.

What is the most significant operational risk?

Misevaluation of fund assets

What are some internal control risks?

N/A

What are some regulatory and compliance risks?

N/A

What are the 3 pillars of the BAAM due diligence process?

N/A

What does BFE do?

N/A

What does legal and product structuring do?

N/A

What does manager seeding and general partner ownership mean?

N/A

What does strategy and risk management do?

N/A

What is Net Working Capital?

NWC = Current Assets - Current Liabilities Current Assets -Inventory -Accounts Receivable -Short Term Assets Current Liabilities -Accounts Payable -Short Term Liabilities An increase in working capital is a use of cash A decrease in working capital is a source of cash

What is Net Debt?

Net debt is a company's total debt minus the cash it has on the balance sheet. Net debt assumes that a company pays off any debt it can with excess cash on the balance sheet.

All else equal, should the WACC be higher for a company with $100 million of market cap or a company with $100 billion of market cap?

Normally, the larger company will be considered "safer" and therefore have a lower WACC. However, depending upon their respective capital structures, the larger company could have a higher WACC.

How does an inventory write-down affect the three statements?

On the balance sheet, the asset account of inventory is reduced by the amount of the write-down, and so is shareholders' equity. The income statement is hit with an expense in either COGS or a separate line item for the amount of the write-down, reducing net income. On the cash flow statement, the write-down is added back to CFO as it's a non-cash expense but must not be double-counted in the changes of non-cash working capital.

What is the difference between public equity value and book value of equity?

Public equity value is the market value of a company's equity; while the book value is just an accounting number. A company can have a negative book value of equity if it has been taking large cash dividends, or running at a net loss; but it can never have a negative public equity value, because it cannot have negative shares or a negative stock price.

If you were CFO of our company, what would keep you up at night?

Step back and give a high-level overview of the company's current financial position, or companies in that industry in general. Highlight something on each of the three statements. Income statement: growth, margins, profitability. Balance sheet: liquidity, capital assets, credit metrics, liquidity ratios. Cash flow statement: short-term and long-term cash flow profile, any need to raise money or return capital to shareholders.

Why might two companies with similar growth and profitability have different valuations?

The difference in valuation could reflect some sort of a competitive advantage that isn't represented on the financial statements. Perhaps the more valuable company is a market leader in a key region or owns uniquely valuable intellectual property or enjoys a significantly stronger management track record.

Which of the valuation methodologies will result in the highest valuation?

The highest valuation will normally come from the Precedent Transactions technique because a company will pay a premium for the projected synergies coming from the merger. A DCF analysis will typically give you the next highest valuation simply because those building the DCF model are somewhat optimistic in their assumptions and projections. Market Comps and Market Value will usually produce the lowest valuations (no control premiums or synergies)

Why do you project out free cash flows for the DCF model?

The reason you project FCF for the DCF is because FCF is the amount of actual cash that could hypothetically be paid out to debt and equity holders from the earnings of a company.

How do you record PPE and why is this important?

There are essentially four areas to consider when accounting for PP&E on the balance sheet: initial purchase, depreciation, additions (capital expenditures), and dispositions. In addition to these four, you may also have to consider revaluation. For many businesses, PP&E is the main capital asset that generates revenue, profitability, and cash flow.

A company has learned that due to a new accounting rule, it can start capitalizing R&D costs instead of expensing them.

This question has four parts to it: Part I) What is the impact on the company's EBITDA? Part II) What is the impact on the company's Net Income?Part III) What is the impact on the company's cash flow? Part IV) What is the impact on the company's valuation? Answer: Part I) EBITDA increases by the exact amount of R&D expense that is capitalized. Part II) Net Income increases, and the amount depends on the depreciation method and tax treatment. Part III) Cash flow is almost unimpacted - however, cash taxes may be different due to changes in depreciation expense, and therefore cash flow could be slightly different. Part IV) Valuation is essentially constant - except for the cash taxes impact/timing impact on the net present value (NPV) of cash flows.

When would a company collect cash from a customer and not show it as revenue? If it isn't revenue, what is it?

This typically occurs when a company is paid in advance for a future delivery of a good or service, such as a magazine subscription. If a customer pays for delivery 12 months of magazine in advance, cash from that purchase goes onto the Balance Sheet as cash, but also increases deferred revenue, a liability. As each issue is delivered to the customer over the course of the year, the deferred revenue line item will go down, reducing the company's liability, while a portion of the subscription payment will be recorded as revenue.

What is valuation and what is it used for?

Valuation is the procedure of calculating the worth of an asset, security, company, etc. This is one of the primary tasks that investment bankers do for their clients. Investment bankers are hired to value a company, often in the context of purchasing another company, selling itself or divesting a division. Investment bankers use valuation in pitch books and other presentations to guide clients toward what they should expect. Private equity firms, hedge funds, asset managers, and others engage in valuation techniques to determine which assets are undervalued, how much to pay for an asset, etc.

What is WACC and how do you calculate it?

WACC = Weighted Average Cost of Capital: used as the discount rate in a DCF analysis to present value projected free cash flows and terminal value. Represents the blended opportunity cost to lenders and investors of a company or set of assets with a similar risk profile. It reflects the overall cost of a company raising new capital, which is also a representation of the riskiness of investment in the company Reflects the cost of each type of capital (debt, equity, and preferred stock) weighted by the respective percentage of each type of capital in the company's capital structure. WACC = [Cost of Equity * %Equity (E/E+D+P)] + [Cost of Debt * %Debt (D/E+D+P) * (1-tax rate)] + Cost of Preferred * (%Preferred) Cost of Equity is the result of the CAPM. Cost of Debt is the result of prevailing interest rates/yields on debt issued by similar companies. Cost of Preferred Stock is the result of prevailing dividend yields on preferred stock issued by similar companies

Under what circumstances does goodwill increase?

When a company buys another business for more than the fair value of its tangible and intangible assets, goodwill is created.

How do you value a private company?

You can value a private company with the same techniques you would use for a public company but with a few differences that make it more difficult. Financial information will likely be harder to find and potentially less complete and less reliable. Second, you can't use a straight market valuation for a company that isn't publicly traded. In addition, a DCF can be problematic because a private company won't have an equity beta to use in the WACC calculation. Finally, if you're doing a comps analysis using publicly traded companies, a 10-15% discount may be required as a 10-15% premium is paid for the public company's relative liquidity.

When calculating Enterprise Value, do you use the book value or market value of equity?

You use the market value of equity because that represents the true supply-demand value of the company's equity in the open market. Book value is the value of the company according to its balance sheet.

Comparable Companies

•Calculates either Enterprise Value or Equity Value. •Average multiple from comparable companies (based on size, industry, etc.) multiplied by the operating metric of the company you are valuing. -3 Most Important Factors = Industry Classification, Financial Criteria (EBITDA, Revenue, etc.), Geography •Most common multiple is Enterprise Value/EBITDA, but also used are P/E, EV/EBIT, Price/Book, EV/Sales. •Different multiples may be more or less important in different industries. •Example: If a similar company is trading at an EV/EBITDA multiple of 6x, and the company you are valuing has EBITDA of $100 million, their EV would be $600 million based on a comparable companies analysis.