Risk Management 2016 - Case Study

Financial Challenges and Opportunities in a

Competitive Economy
Part A: Presentation on:

Financial adaptability and cooperation in case of economic

distress
Academy of Economic Studies, Faculty of Finance: Adrian Mitroi, PhD, CFA,
MBA, Doru Pohrib & Andrei Andon-Ioni

The participants should consider the Learning benchmarks:

Understand the concept of financial adaptability and cooperation in
todays complex economic business environment
Evaluate the confluence of macro (systemic risk) to corporate
(sector, domicile, unique) and individual context (rationality vs non
rationality)
Understand the global macroeconomics and economic policies that
influence investment and economic decisions making
Prepare with a good addition of investment and risk finance
Professional Competency on effective risk management assessment
and control the multitude sources of risk: market and non-market,
rational and non-rational
Understand some of the trends in the Investment and Risk
Management decision
Reach an investment decision considering all the factors affecting
the decision.

Part B: Presentation on:

Risk Management Case Study
Academy of Economic Studies, Faculty of Finance: Adrian Mitroi, PhD, CFA,
MBA, Doru Pohrib & Andrei Andon-Ioni

The participants' learning and instruction goals:

This course supports the following learning goals for the Risk
Management participants:

 Clearly Define the Investment Decision (IT vs. Real Estate), Profiling
at Risk
Aimed at building Strong Team Relations and Interpersonal Skills
Apply Critical Thinking. Lateral, out of the box. Assertive yet
constructive presentations
The ability to build and present a thorough rationale
Each Team Member should clearly define his role (Chief Risk Officer,
Chief Market Risk Officer, Chief Political Risk Officer, Chief
Operational Risk Officer, Chief Business Risk Officer)
Define a Commitment to Ethical Practice and Service, Lifelong
Learning
Understanding and managing risk while keeping in mind the market
uncertainty

CASE STUDY
Investment Decision Making for Risk Management
You have the time from Tuesday until the moment of your presentation to
prepare your ideas. Please be succinct and compress your findings into 3
slides, to be presented in 8 minutes. In formulation your ideas pls. refer to
concepts delivered during your time here at Risk Management and feel
free to use any additional source to strengthen your arguments. You can
find additional inspiration in the appendix 1 and 2. Please make effort for
all your team members to have a relevant role, both in your decision and
during your presentation. Also, highlight special skills, show capabilities,
commitment, and motivation and present the team as a unit with clear
problem solving philosophy for the 2 parts of the case study.
Without risk we have a limited possibility of reward. First company
develops both Android and iOS <economic> apps. As the investment
manager, you are contemplating investing some of your money into equity
of the enterprise. You are expected to formulate your financial and
investment risk profiling and apply the conclusions to the investment
decision-making for this company. You, as a hedge fund Risk Board, need
to decide to allocate efficiently your money into the Apps Development Co
or the Bucharest One Real Estate Project this is the alternative.
Case Study has 2 parts. Please present one slide for each section and
reserve 3-4 minutes for Q&A. Each team member is expected to deliver at
least one comment/bullet:
You have to decide and justify your decision if any (or both) of the
companies are a good fit to your investment portfolio. Use your risk
management abilities in making this estimation. Show your logic for
the answer.
You have to decide how much of your initial capital would you invest,
if any, in the company. Use your risk management techniques and
insights for making this estimation. Show your logic for the answer.
You have to prepare a pitch for the shareholders in order to convince
them to provide you the necessary funds (whatever amount you

deem necessary for the investment). Feel free to be spontaneous

and very convincing in order to obtain the desired funds
You and your team can use all your knowledge acquired at the Risk
Management conferences in order to surprise the audience with your
solutions to the case study.

Company 1 (an Apps Development company: Apps for

the Internet of Things)
#IoT: Adding Value to Peoples Lives

The Internet of Things (IoT) represents a network of physical objects

devices, vehicles, buildings and other itemsembedded with
electronics, software, sensors, and network connectivity that enables
these objects to collect and exchange data. The IoT creates opportunities
for more direct integration of the physical world into computer-based
systems, and resulting in improved efficiency, accuracy and economic
benefit.
Each object is uniquely identifiable through its embedded
computing system but is able to interoperate within the existing Internet
infrastructure. Experts estimate that the IoT will consist of almost 50
billion objects by 2020.
Of all the technology trends that are taking place right now, perhaps
the biggest one is the Internet of Things; its the one thats going to give
us the most disruption as well as the most opportunity over the next five
years. One of the most noteworthy factors that will lead to this
development is the fact that big data is only getting started. Today, only 1
percent of all apps use cognitive services; by 2018 (in other words, in
three years), 50 percent will. Essentially, analytics will be embedded in
every application, used to facilitate functionality or convenience.
Moreover, enterprises are turning away from traditional vendors and
toward cloud providers. Theyre increasingly leveraging open source. In
short, theyre becoming software companies. By the End of 2017, Two-

Thirds of the CEOs of Global 2000 Enterprises Will Have Digital

Transformation at the Center of Their Corporate Strategy.
Today, there are hundreds of IoT startups, offering myriad
possibilities for investors. Having already gained the investors confidence
and having secured millions of dollars in startups, some of the most
promising IoT companies include AdhereTech (which aims to provide a
connected pill bottle that ensures patients take their medications), Chui
(whose goal is to combine facial recognition with advanced computer
vision and machine learning techniques to turn faces into "universal
keys.", a solution referred to as "the world's most intelligent doorbell) and
Heapsylon, a company geared towards turning clothes into computers.
As you can see, diversity is key.
However, enthusiasm is not the only feeling surrounding the IoT
industry. Memories of the dot-com bubble, a historic speculative bubble
covering roughly 19972000 during which stock markets in industrialized
nations saw their equity value rise rapidly from growth in the Internet
sector and related fields before crashing still persist.
Critics say that Unicorns are trading at ridiculously over evaluated
rates while the IPO market is screeching to a halt in the USA, the
worldwide powerhouse regarding IT Development. Moreover, one of the
big reasons for the blowing up of the latest bubble has been big money
tourists e.g., mutual funds, hedge funds and other institutions that are
not experts in helping to grow technology startups. Todays promises and
even certain checks may become tomorrows broken dreams. There is also
the undeniable fact that some of the Unicorns are tightening their belts- in
October 2015, E-commerce site Fab.com once valued at close to $1
billion suffered mass layoffs before it was acquired for an undisclosed
amount in March. Evernote, valued as a unicorn in 2012, laid off 47 people
and closed three of its global offices this week.
Internet of Things (IoT) in the CEMA (Central Europe, Middle East and
Africa) Region is a market with a sudden growth. Although still in its initial
phase, the IoT technology offers positive perspectives for the rest of the
current decade and large companies are researching the markets and
investing in local companies, even in Romania. The results of a recent
study show that 1/3 investors are open to investing in IoT in the following
1 to 3 years.
The preferred area for most IoT investors is that of apps for the
financial sector (39%), followed by apps geared towards businesses (37%)
and transportation (36%). Apps aimed at the public sector currently attract

only 21% of investors. Today, the most noteworthy Romanian IoT

development companies are uRADMonitor, Symme 3D, Device Hub.
Last but not least, there are two important demographical and
cultural aspects: the Romanian workforce and the degree of openness of
the Romanian population towards new technology. There is a thin segment
of very talented students in Mathematics and Computer Science, including
students that have won international contests and/or internships at the
headquarters of IT powerhouses such as Facebook and Google. On the
other hand, although the present rate of usage for IoT technology in
Romania is very low, the high degree of interest shown by the Romanian
consumer towards technologies such as SmartTV or Cloud based solutions
conveys a modern market with a high potential in the IoT area.

Probability

Expect Optimis Pessimis

ed
tic
tic
45%
15%
40%
29,166
6

52,571

-3,435

Net income

8%

21,875
%

-10%

P / E at exit

15

20

14,5833

35

230

Revenue in year 5

Company value at
exit
Blended value at
exit

52,25

Investor
required
IRR
Current companys
value

37%
10,83

The three scenarios represent varying growth and profitability

expectations; also the macro conditions can affect the probabilities
assigned. The expected scenario (most likely) assumes 29.16 million in
revenue in five years, with a net income margin of 8 %. The potential exit
is a sale of the company to a strategic competitor. For a P/E of 15, the exit
vale of the company (in the most) likely scenario is around 35 million.
The same type of calculation is performed for the other two scenarios.
Multiplying the company value for each scenario with the assigned
probability and adding the three gives a so called blended value at exit
at around 52.5 million. If we assume you have a five-year investment
horizon for the potential investor, and using an IRR of 37 % (in /RON,
depreciation adjusted), the present value of the company is 10.83 mil.
post financing. The objective of the venture capitalist is to earn a 35-60%
annual return, net of inflation; this high range reflects the potential returns
necessary to invest in hi tech company; investors can make their money
when / and only at the time that they are exiting. Rates of return are
extremely sensitive to time. Next, assuming that the present value is also
the agreed-upon price, the investor ends up with about 28 % ownership for
1.5 million investment. The calculation could also include the
expectation for additional financing.

Company 2
Real Estate Development
Bucharest One Tower

in

Bucharest

The

Changes in legislature and consolidation on headquarters of mammoth

companies will lead to significant changes in the office real estate market.
Old buildings of inferior quality will be left out of the office picture,
whereas companies will move on to newer, better positioned spaces.
Regarding rentals of office spaces, experts are feeling optimistic. They are
estimating a year-on-year growth of 25%. 2016 will bring major changes

on the office spaces market. Companies have been constrained by law to

run their business in safe places, while the toughening safety measures
have incentivized them to move to higher quality office spaces. 2016 is a
year where mass relocation of business is going to be the norm.

Most probably, 2016 will be the first stage when office spaces of weaker
quality in Bucharest will be left behind. According to real estate experts,
big pre-rental contracts of large office spaces, with surfaces ranging from
10.000 to 40.000 sqm will lead to the freeing up of space in class A and
B+ building in the center of Bucharest. In 2016, three large pre-rental
contracts are announced: two big banks and one IT&C firm want to
improve on their office space. In doing that, they are looking for spaces of
over 15.000 sqm.

The total number of leased square meters of office space was 240.000, a
20% decrease over the figure in 2014. The 2015 figures represent the
result of the market context in the crisis years 2009 2010, when few
transactions struck a deal, most of them having a due date of 5 years.
Therefore, last year, few contracts expired, meaning few tenants where in
the unpleasant situation of searching for office spaces. It is expected that
the number of new rental contracts to pick up in 2016, due to the fact that
lots of contracts are to be signed in the next 9-12 months, it is shown in a
CBRE report.
Regarding the real estate market, the office segment is currently the one
developing at the quickest rate. This year should set a new record for the
Bucharest market, as 408.000 square meters of new office space will be
delivered, a growth of approximately 500% from the previous year,
according to CBRE. The figure is 10% larger than the one registered in
2009, the previous best year for the Bucharest real estate market.

However, a migration of the demand from the established office

hubs in the North and Pipera areas towards Western Bucharest is looming
on the horizon, a fact that should make the market more dynamic. The
IT&C sector is the one renting the most office space, having rented
330.000 sqm of office space. (during 2015, the demand in the IT&C sector
represented 51% of the total demand).

The Bucharest One real estate project is located at the junction

between Calea Floreasca and Barbu Vcrescu Bd. The area is rapidly
becoming Bucharests newest business hub, with the most office and retail

buildings nearing completion. Currently, this is the preferred area for large
companies looking for new office spaces, as it is conveniently located in
the northern side of the city and can be easily reached by public transport
(bus, metro and tram). When topped out, the Bucharest One tower will be
the second highest building in Romania and will feature a sizeable retail
area at ground floor, including a supermarket, showrooms, banks and
cafes.

The analysis is based on a number of assumptions: growth for 3 years, a

weighted average price to net income of 16. The valuation scenario
considers a potential exit through the sale of the less than 100% of equity
capital to a strategic player. A sale of the whole equity capital could add a
majority/control premium (usually in the range of 20 to 40 %) on the top of
the estimated value. So a careful examination of these possible techniques
can help you as an investor make a better appraisal of the value.

Scenario
conservative
Scenario's
55%
probability
Estimated
rent
12,96
revenue
(sales)
Estimated
net
operating
1,80
income at
exit
Estimated
net income
2,33
at exit
Price/incom
16
e at exit
Value at exit
(net income
based)
Weighted
value
(net
income
based)
Present value
(net income
based)

optimistic

pessimistic

25%

20%

16,06

8,90

2,18

1,18

3,21

2,08

20

52

18

30
33
17

Part C: Presentation on: Unforeseen Risk Management Scenario

Risk Management Case Study
Academy of Economic Studies, Faculty of Finance: Adrian Mitroi, PhD, CFA,
MBA, Doru Pohrib & Andrei Andon-Ioni

You will be faced with an unforeseen circumstance, both at a team level,

as well as individually. You will be requested to apply the concepts you
learned throughout the week, in high incertitude circumstances.
In the third part of the presentation, you will have to respond to a takeover
offer made by a new hedge fund on the market. It wishes to acquire you
and at the same time he is evaluating an eventual employment, partial or
of the whole team.
The way you present the answer both regarding the unforeseen event and
the takeover situation will see you get a new job in the management team.

Good luck!