Market feasiblity approach adjacent market final

Work Examples – Market Feasibility 1

FrontLine Partners Viewpoint Series Market Feasibility Approach Adjacent Markets

Examples of Work Conducted in the Trading Platform Market Structured Finance Market Extension: Approach to Build / Launch / Execute

www.frontlinepartners.net

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Define the Market and Its Size Defining trading markets requires an understanding of the market and its products

CAPITAL UNDER MANAGEMENT

CAPITAL COMMITMENTS TO US VENTURE FUNDS

$BN

1.0 2.3

8.0

14.0

20.0

26.3 24.9

32.3

45.6

26.2

0

10

20

30

40

50

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

RETURN ON EQUITY(1)(%)

INVESTMENT BY INDUSTRY SECTOR

$BN

0.6 1.0 0.33.3 3.8 5.2

1.2

6.310.4

18.7

35.1

4.0

0

10

20

30

40

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 1998 1999E

21.4%

16.7%16.1%

0%

5%

10%

15%

20%

25%

Expansion andMezzanine Fund

Seed and Early StageFund

Balanced Diversif iedFunds

RO

E (%

)

Computer Software

Communication

Consumer Related

Medical and Health

Other

Internet Specific

15%

5%

5%

6% 20%

39%

Average Return (17.4%)

EXAMPLE MARKET SIZING




Define the Market and Its Products Defining trading markets requires an understanding of the market and its products (cont.)

EXAMPLE PRODUCT DEFINITION

MARKET SIZE, GROWTH, MIX

PRODUCT DEFINITION

• Venture capital investing has grown from a small investment pool in the 1960s and early 1970s to a mainstream asset class that is a viable and significant part of the institutional and corporate investment portfolio

» Venture capitalists invested over $13 billion in about 2500 companies in the United States alone (approx. $5.4M per company)

» Capital under management in the U.S. is around $45.6B by more than 3,000 professional venture capital providers

» New funds raised by venture capitalist rose sharply from $3.1BN (1992) to $18.7BN (1998)

• Venture capital volume is concentrated in the U.S. market with Europe and Asia growing quickly

» High appetite for risk and an entrepreneurial culture results in a strong need for start up capital in the US

» The European and Asian markets are less developed than the U.S., although growing rapidly

• The main drivers of growth comes from Internet start-ups and technology companies that have sprung up to take advantage of the paradigm shift in retail and corporate commerce

» Internet specific investment accounted for 39% of new capital raised in 3Q 1999

» Computer software related investments accounted for 15% of capital raised in 3Q 1999

• Venture capital is money provided by professionals who invest alongside management in young, rapidly growing companies that have the potential to develop into significant businesses. Venture capital is an important source of equity for start-up companies

• Professionally managed venture capital firms generally are private partnerships or closely-held corporations funded by private and public pension funds, endowment funds, foundations, corporations, wealthy individuals, foreign investors, and the venture capitalists themselves

• Venture capitalists generally:

» Finance new and rapidly growing companies

» Purchase equity securities

» Participate in Management and Leveraged Buyouts (LBO & MBO)

» Assist in the development of new products or services

» Add value to the company through active participation

» Take higher risks with the expectation of higher rewards

REVENUE POOL / MARGINS

MAJOR PLAYERS

• The venture capital market is similar to a mutual fund industry in terms of revenues:

» Main revenue is the potential increase in the value of the firm resulting in a return on the equity invested. This is normally realised through exit of the venture investment by means of a merger, acquisition or an initial public offering (IPO)/private placement

» In addition, as an investment manager, the general partner will typically charge a management fee to cover the costs of managing the committed capital, usually 2-3% per annum of the capital raised

• The 10 year average return on equity for venture capital investments are around 17.4%

» The seed and early stage funds return 21.4%

» Expansion and Mezzanine funds showed a return of 16.1%

• The European average return is 11.6%

• The four major types of players in this market are:

» Government Departments: usually in the form of loan guarantee schemes (e.g. SBIC program in the US) and tax incentives (e.g. Venture Capital Trust in the UK)

» Venture Capital professionals: Also called ‘fund managers’ or ‘general partners’. Usually manage investment schemes; typically raise “closed end” investment funds from institutional investors such as private and public pension funds, endowments, corporations, high net worth individuals, and wealthy families. Some venture capital professionals manage ‘open-end’ funds that increase in size as they invest in companies

» Incubators: provide services aimed to help companies in their professional image projection and provide orchestrated access to critical business support

» Investors: Also called ‘limited partners’; provide capital; typically private sector venture capitalists, private investors, pension funds, insurance companies and banks

» Venture Capital Associations: Help fund start-ups and encourage venture investment (e.g. British Venture Capital Association




Example Trading Activity Chain Once the market is sized, FrontLine Partners works to understand the trading environment and analyze how things work in the industry/market

Greatest source of value, cost

Least source(s) of value, cost

Areas under change due to market trends Industry utility 0 4

• Confirmation • Transaction

settlement • Fees processing • Feed to books,

records and G/L • Reconciliation • Custody • Information

management

• Exposure limit setting/ monitoring

• Credit risk limit management and monitoring

• Regulatory reporting

• Trader position monitoring

• Hedging • Proprietary

trading

• Principal trade (risk taking) or agency trade (executed on exchange or OTC)

• Data collection and analysis

• Packaging • Delivery

• Price quotation • Order

management • Advice to clients

on current trends

• Account planning

• Periodic discussions of needs

• Introduction of research analysts and product specialists as needed

Key Processes

Value Chain RISK MANAGEMENT

TRADING/ POSITION

MANAGEMENT

ORDER EXECUTION RESEARCH SALES RELATIONSHIP

MANAGEMENT OPERATIONS

Sources of Value to

Customer Sources of Cost

to Supplier

Risk Management solution providers: Reuters, BARRA,

SunGard

Sell Side: GS, ML, JP, MS, SSB

1 0 0

3 2 1 1

4 1 1 3 2 3 1

Custodian: State Street, Bankers

Trust, Chase Manhattan

Pure market maker:

Knight/Trimark

Pure agency broker: ECNs

Specialist research

companies: Princeton

Economics




Fund Admin Custody Execution Portfolio

Management Distribution

$34.0 $6.0 $8.5 $41.0 $2.4 $91.9

37% 7% 9% 44% 3% 100%

Total Value Captured (2)

As % of total

29 bp

• Fund administrators

• Custodians • Broker/dealers • Fund managers • Pension Consultants

• Fund managers (i.e., direct sales)

Key Intermediaries

Value Capture Mechanism

Growth Rates

Trends

• Fees paid by plan sponsors on services performed (e.g., customized report generation) -- bundled together with management fees

• Securities borrowing / lending fees (off P/L) earned by custodians

• Fees on AUM paid by fund managers (off P/L), incurred directly by plan sponsors

• Commissions and spread paid by fund managers (off P/L), incurred directly by plan sponsors as lower AUM

• Management fees paid by plan sponsors

• Fees paid by plan sponsors based on amount invested

• Increased value attributed to fund administration services by end customers

• Proliferation of services required (e.g., account aggregation)

• Commoditization of services leading to margin compression

• Increasingly used as a loss leader for fund administration services

• Increasing competition for buy side wallet leading to pressure on spreads and commissions

• Disintermediation of broker/dealers’ electronic dealing platforms & crossing networks

• Greater performance accountability, enhanced premium placed on good performance

• Globalization

• Proliferation of fund types

• Increased demand for personalization

• Growing power of pension consulting services

5 bp 7 bp 35 bp 2 bp 78 bp

EXAMPLE OF ANALYSIS ON PRIMARY POOLS OF VALUE

Fastest growing

Slowest growing

Market Overview Framework for Valuing Markets Next we translate the activity chain into pools of value and analyze each one for total market and percentage of value in the process




Fund Admin Custody Transaction

Processing Execution Risk Portfolio Management Research Sales &

Marketing

55%

0.4 bp

0.6 4%

0.5 bp

2.0 19%

1.7 bp

0.8 19%

0.7 bp

1.1 12%

0.9 bp

5.2 9%

4.4 bp

1.7 13%

1.4 bp

4.3 50%

3.6 bp

14.0 36%

13.7 bp

0.3 7%

0.3 bp

5.2 39%

5.1 bp

1.1 29%

1.1 bp

3.4 7%

3.4 bp

8.4 23%

8.2 bp

2.3 37%

2.2 bp

20.9 19%

20.5 bp

2.0 2.0 2.0 1.0 3.5 5.0 1.0

4.3 0.5 2.0 0.8

2.3 14.0 5.2 1.1 8.4

Institutional Fund Mgr Costs (2)

17.9 50%

15.2 bp

59.7 50%

58.5 bp

16.5

Retail Fund Mgr Costs

Available to Service

Providers

Key Trends / Drivers

SECONDARY POOLS OF VALUE

Pressure points: Activity Growth > Average Growth CAGR (Yr 1-Yr 3)

Total cost in $bn

Costs per AUM

$ bn %

bp

• STP - need for bundled back office solutions

• Shift from batch processing to real-time messaging

• Need for customer data aggregation

• STP

• T + 1

• Globalization and deregulation

• Diffusion of market liquidity

• Regulatory shift towards more disclosure and new reporting requirements

• Increasing sophistica-tion of portfolio analytics

• Increasing complexity of manufact-uring

• Information overload

• Pressure on soft dollar arrangement

• Consolidation of wealth mgmt tools

• More demand for personali-zation

• Greater performance accountability

Growth Rates

Fastest growing Slowest growing

Finding the Underlying Value Points Then we go one step future and figure out where the underlying value is in the market place




Figuring Out How the Industry Works Knowing the key value points of an industry is only useful once it is applied to the primary market interactions – this is where value is determined for a trading system

LEGEND

Role

Type of Interaction

Number of players in role

Frequency of Interaction

Flow of information

Nature of interaction

1-2 3-10 >1000

Transactional Informational

Administrative

Description on facing page

Monthly or less Weekly Daily Hourly

One way

Two way

One-to-one One-to-many Many-to-many

11-100 101-1000

Investors

Hedge fund

Info. prov.

Acct. Admin

Prime broker

OTC

Research

Mkt.

Ex. broker

Stock loan

Repo ECN

EXAMPLE TRADING MARKET INTERACTION ANALYSIS




Understand the Key Market Players We believe the best way to source deal flow is through other internal trading and execution platforms that is why we spend the time to get to know the market players

SERVICE PROVIDERS BY TYPE

Note: Full service provider solutions and internally-developed solutions can range across the entire activity chain

Execution Fund Administration

Research, Content & Analytics

Transaction Processing Custody Sales &

Marketing Portfolio

Management

Prime Brokers

Custodians / Fund Administration

Risk Management

ECNs / Trading Communities

Order Mgmt

Account Aggregators

Portfolio Mgmt, Analytics & Decision Support

eCRM

End-customer empowering

direct marketers

Market Data & News Vendors

Artificial Intelligence Systems

STP Enabler

Back Office Systems

Infomediaries/ Communities

Ratings Groups

Middleware / Messaging / Data Distribution

Portfolio Accounting

Transaction Cost Analysis

Knowledge Aggregator

Functionality can overlap e.g., modeling capabilities Closely related, enable straight through processing in back office functions

VALU

E C

HAI

N

ACTI

VITI

ES

PRO

VID

ERS




Know the Trader/Customer FrontLine Partners knows that traders are creatures of habit and like proven methods, we go beyond the market and get in the heads of the user

Valuating market information (e.g., price,

supply/demand) 27%

Trader Productivity

Set trading strategy 21%

Execute deal 10%

System Performance

17%

Create reports (e.g., P&L, VAR, Curves)

13%

Deal workflow management (e.g.

logistics, modification)

12%

Drivers of Trader Productivity

• User-friendly, intelligent deal entry interfaces

» Contracts with up to 50 fields routinely captured in 30-60 seconds; most trades entered within 10-15 minutes

» Automatic data entry for logistics details

• Single data entry and integrated front and middle office systems to reduce manual reconciliation

• Credible system-generated reports on as-needed basis

• Web exchanges to reduce broker chit-chat and facilitate digital data flow

Inefficient Trader Time




Value the Important Functions Electronic trading platforms need to address the critical market components to enable liquidity

SAMPLE TRADING PLATFORM HEATMAP

Processing Impact Minimum Maximum

Credit Assessment

Information Provision Pricing Logistics Trading Valuation Middle

Office Risk

Management

Forwards

Financial

Options

Com- modity

Non- Com-modity

Futures OTC

Short Term

Long Term

Swaps

Exchange

Straddle

Spread

Asian

Put/Call

Metals

Coal

Oil/Gas

Weather/ Temperature

Products Instrument

Pre-Trade Work Flow Post-Trade Work Flow




Build the Business Case Finally, FrontLine Partners takes the industry and trader specific knowledge and builds a business case to provide our clients with recommendations and direction

SUMMARY BUSINESS ASSESSMENT

Community value score

3 A

3 B

3 C

4 D

4 E

3 F

Community

Score along value creation dimensions

Financial value

3

Feasibility, immediacy

4

Sustain- ability

2

Member-ship

3

1 4 4 3

4 4 2 2

4 4 4 3

4 4 4 3

1 4 4 3

Estimate of financial value creation

Source of value Value attribution methodology

Potential value ($m)

Block trade facilitator

Lower transaction costs; lower search costs

Potential savings to institutional investors in market impact(2) 650

Research quality aggregator

Higher confidence Maximum earnings associated with research ratings business of Institutional Investor Magazine(3)

<40

Institutional sales communities

Better information; personal relationship

Commission part of sell-side revenues associated with trades executed for institutional investors(4)

15,000

Middle office / back office

Lower transaction costs

Total sell-side clearance expenditures(5) 1,200

Execution communities

Lower transaction and search costs

Total revenues of ECNs, exchanges, and IDBs(6) 4,200

Sector trading information

Better information; new trade ideas

Total industry revenues in sector trading information(7) <100




Build the Business Case Finally, FrontLine Partners takes the industry and trader specific knowledge and builds a business case to provide our clients with recommendations and direction

SCORE

VALUE CATEGORY

Financial value creation

Value creation score

DESCRIPTION

The total potential annual revenue associated with the activity underlying the community

POOR (1)

< $100 million

FAIR (2)

$100m-$500m

GOOD (3)

$500m - $1 billion

EXCELLENT (4)

> $1 billion

Total of the above scores, expressed on a scale of 1-4

<8 8-11 12-14 15-16

Feasibility & Immediacy

How feasible is the community in the near term (e.g. due to regulation, technology, market dynamics

Serious obstacles mean currently unfeasible

Obstacles can be overcome

No current obstacles

Demonstrable need

Sustainability The number of years the community is likely to retain the majority of its value potential (including momentum)

Trends already undermining value within 1 year

Value likely to sustain for 2-3 years

Supported by current trends: 3-5 years

Aligned with long term industry trends: > 5 years

Membership Number of member organisations - a broad membership increases exposure

Small: < 50 Medium: 50-1,000 Large: > 1,000 N/a




FrontLine Partners Overview

FrontLine Partners (www.frontlinepartners.net) is a management consulting firm that works with banks, institutional investors, lenders, owners, intermediaries, and service providers in the commercial real estate and financial services industry to help them accelerate growth of their business or repositioning of their business model and assets.

FrontLine Partners offers a number of services ranging from strategy formation, corporate and business development, mergers and acquisitions, capital sourcing, loan work-outs and corporate restructuring. Refer to our website at www.frontlinepartners.net for additional information.

For further information on your unique needs, please contact our Managing Partner - Jim Vincent at 214.369.2085 – for a free initial consultation.



http://www.frontlinepartners.net/

http://www.frontlinepartners.net/

Market feasiblity approach adjacent market final

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