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Issuing Securities and the Role of Investment Banking

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Issuing Securities and the Role of Investment Banking Powered By Docstoc
					           Issuing
         Securities
       and the Role               15
       of Investment
          Banking
        Corporate Financial Management 3e
              Emery Finnerty Stowe
19-1
                 Chapter Outline

       15.1   The Long-Term Financing Menu
       15.2   Common Stock
       15.3   Issuing Securities
       15.4   Investment Banking
              and the Cost of Issuing Securities
       15.5   Private Placements
       15.6   Rights Issues
       15.7   Dilution
       15.8   Going Public and Going Private
       15.9   Preferred Stock
19-2
               Raising Long-Term Funds
                       Externally
          Main sources:
              Common stock
              Preferred stock
              Debt
          Flotation costs
              Fixed costs
              Variable costs
          Issue Methods
              Public offering
              Private placement




19-3
                     Public Offering
          General cash offer
            Securities are offered to investors at large.
            Underwriters are usually used.

          Rights offering
            New common stock is sold to existing
             stockholders.
            Underwriters are sometimes used.




19-4
                 General Cash Offers
          Decide what to issue:
            Amount of capital to be raised
            Type of security
        Obtain required approvals.
        File a registration statement:
            Must be approved by the SEC prior to the
             actual sale
            Preliminary prospectus
            Red herring



19-5
               General Cash Offers
        Determine initial pricing and file an
         amended registration statement.
        Close the offering.




19-6
            Primary and Secondary
                  Offerings
        In a primary offering, the firm sells
         newly issued shares to investors.
        In a secondary offering, insiders and
         large institutional shareholders sell
         shares they hold in a registered public
         offering.




19-7
               Role of the Underwriters
          Investment bankers
              An intermediary between the issuer and the
               purchaser.
              Provide advice regarding type of security, terms,
               and price.
              Help prepare documentation.
          Underwriting
              A form of insurance.
              Underwriters bear the price risk.
          Syndicated offering process

19-8
               Role of the Underwriters
          Underwriters’ compensation
              Gross underwriting spread
                 Management    fee (15% to 20%)
                 Underwriting fee (15% to 20%)
                 Selling concession (60% to 70%)

          Other out-of-pocket expenses
            Legal fees
            Accounting fees
            Printing costs


19-9
                  Flotation Costs
     Include both the gross underwriting
      spread and the out-of-pocket expenses.
     Economies of scale
     Vary by security type: Holding issue size
      constant,
         Common stock has the highest flotation
          cost.
         Bonds have the lowest flotation cost.
         Flotation cost of preferred stock is in
          between.

19-10
        Negotiated versus Competitive
                  Offerings
       In a negotiated offering, the issuer
            selects one or more firms to manage the offering.
            works closely with them in designing and pricing
             the issue.
       In a competitive offering, the issuer
            specifies the type and amount of security to be
             sold.
            selects the investment banker through a
             competitive bidding process.



19-11
             Shelf Registration
     Since November 1983, the SEC allows
      firms to register an inventory of
      securities for up to two years.
     Issuer can then sell securities at any
      time within this time period.
     Shelf registration gives firms financial
      flexibility and reduces flotation costs.



19-12
              Private Placements
     Securities are sold directly to institutional
      investors.
     Exempt from registration requirements.
     Private placements are restricted:
         Limited number of investors may be offered
          the securities.
         Restrictions on resale.




19-13
          Advantages of Private
              Placements
     Lower issuance costs.
     Issue can be placed quickly.
     Greater flexibility of issue size.
     Greater flexibility of security
      arrangements.
     More favorable share price reaction than
      a public offering.
     Lower cost of resolving financial distress.


19-14
        Disadvantages of Private
              Placements
     Higher yield required by investors.
     More stringent covenants and restrictive
      terms.




19-15
            Largest Buyers of Private
                  Placements
     John Hancock Life          AIG/SunAmerica
        Insurance                  Investments
     Teachers Insurance &       Principal Capital
        Annuity Association        Management
     Prudential Insurance       Cigna Investment
     Hartford Investment           Management
        Management Company      ING Investment
     Metropolitan Life             Management
     Citigroup Global           Provident Investment
        Investments                Management
     American General           Nationwide Insurance
        Investment                 Companies
        Management
     New York Life Investment
        Management
19-16
            Main Features of Common
                      Stock
       Features specified in the corporate charter
       Perpetual security
       Not redeemable
       May or may not have a par value
       Charter specifies the number of authorized
        shares:
           Outstanding shares
           Treasury shares
       Multiple classes of common stock are possible

19-17
            Rights and Privileges of
                Common Stock
     Dividend rights
     Voting rights
         Cumulative
         Noncumulative
         Voting by proxy

     Liquidation rights
     Preemptive rights




19-18
         Public Offering of Common
                    Stock
       Cost of offering
         Gross underwriting spread
         Out-of-pocket expenses
         Market impact

       A firm’s share price often declines upon
        the announcement of a public offering.
           Managers sell new shares when shares are
            overpriced.


19-19
                 Rights Offerings
     Firm issues one right per share
      outstanding.
     Rights are call options on newly issued
      shares:
         subscription price
         subscription period
     Rights are issued in-the-money.
     Rights offerings are frequently
      underwritten.

19-20
                    Rights Offerings
       Advantages
           Allows shareholders to retain their proportionate
            ownership in the firm.
           Protects existing shareholders from loss of wealth
            resulting from a public offering.
           Beneficial if firm does not have broad ownership.
       Disadvantages
           Takes longer to complete.
           Cannot sell large blocks of new shares to
            institutional shareholders.



19-21
                  Rights Offering

       Stansfield Enterprises currently has 1,000,000
        shares outstanding trading at $10 per share.
       The firm announces a rights offering.
       Current shareholders are allowed to buy one
        additional share for every share they
        currently own at a subscription price of $9.50
        per share.
       Shareholders who do not wish to exercise
        their rights may sell them.
       It sounds like a good deal, an opportunity to
        buy a $10 stock for $9.50.
       Is it that good of a deal?
19-22
                  Value of a Right
       What is the value of one right?
       To determine this, let’s look at the value of the
        firm after the rights offering.
       There will be 2,000,000 shares outstanding
        and the firm will have raised additional equity
        of $9,500,000
       The new share price will be $9.75


                   $10,000,000 old equity  $9,500,000 new equity
 $9.75 per share 
                                  2,000,000 shares
19-23
             The Value of a Right

       A shareholder who chooses to exercise
        his rights starts with one $10 share,
        pulls $9.50 out of his wallet and finishes
        the day with 2 shares of a $9.75 stock
        for a total portfolio value of:
                  $9.75 × 2 = $19.50.



19-24
           The Value of a Right

     If he does nothing, he goes to bed with
      one share of a $9.75 stock and $9.50 in
      his wallet.
                  Total = $19.25
     Doing nothing will cost him $0.25




19-25
           The Value of a Right

     He can avoid that loss by exercising the
      right with $9.50 in cash and then selling
      the extra share for $9.75
     So, we can be pretty sure that he won’t
      sell his right for less than $0.25




19-26
             The Value of a Right
       Can he sell his rights for more than
        $0.25?
         Consider an outsider. Would he pay $0.26
          for a right?
         This right will allow him to buy a $9.75
          stock for $9.50 plus the cost of one right.
         Any rational outsider will pay at most $0.25




19-27
              The Value of a Right
       Clearly, if the least a seller will take is
        $0.25 and the most a buyer will pay is
        $0.25, it’s a pretty good bet that the
        rights will have a market-clearing price
        of $0.25.




19-28
        Calculating the Ex-rights Price

       Consider the value realized by our
        shareholder who sells his rights.
       He wakes up in the morning with a $10 stock.
       Sells the right stapled to it for $0.25
       Goes to bed with a $9.75 stock and $0.25 in
        the drawer of his nightstand.
       The ex-rights price is $9.75. If it was
        anything else there would be an arbitrage
        opportunity.
19-29
                  Rights Offering

       Now suppose Stansfield Enterprises currently
        has 1,000,000 shares outstanding trading at
        $10 per share.
       The firm announces a rights offering.
       Current shareholders are allowed to buy one
        additional share for every two shares they
        currently own at a subscription price of $9.50
        per share.
       Shareholders who do not wish to exercise
        their rights may sell them.

19-30
               The Value of a Right
        What is the value of one right?
        To determine this, let’s look at the value of the
         firm after the rights offering.
        There will be 1,500,000 shares outstanding
         and the firm will have raised additional equity
         of $4,750,000.
        The new share price will be $9.83.


                  $10,000,000 old equity  $4,750,000 new equity
$9.83 per share 
                                 1,500,000 shares
19-31
             The Value of a Right

       A shareholder who chooses to exercise
        his rights starts with two $10 shares,
        pulls $9.50 out of his wallet and finishes
        the day with 3 shares of a $9.83 stock
        for a total portfolio value of:
                  $9.83 × 3 = $29.50.



19-32
           The Value of a Right

     If he does nothing, he goes to bed with
      two shares of a $9.83 stock and $9.50
      in his wallet. Total = $29.16
     Doing nothing will cost him $0.33.




19-33
           The Value of a Right

     He can avoid that loss by exercising the
      right with $9.50 in cash and then selling
      the extra share for $9.83.
     So, we can be pretty sure that he won’t
      sell his right for less than $0.33.




19-34
             The Value of a Right
       Can he sell his rights for more than
        $0.33?
         Consider an outsider. Would he pay $0.34
          for a right?
         This right will allow him to buy a $9.83
          stock for $9.50 plus the cost of one right.
         Any rational outsider will pay at most $0.33.




19-35
              The Value of a Right
       Clearly, if the least a seller will take is
        $0.33 and the most a buyer will pay is
        $0.33, it’s a pretty good bet that the
        rights will have a market-clearing price
        of $0.33.




19-36
        Calculating the Ex-rights Price

     The ex-rights price is $9.83.
     If it was anything else there would be
      an arbitrage opportunity.




19-37
        Dividend Reinvestment Plans
                  (DRiPs)
     A DRiP allows each shareholder to use
      the dividends received to purchase
      additional shares of the firm’s stock.
     Purchase price is often below market
      price (5% discount).
     Resemble rights offerings.
     Lower transaction costs for purchaser
      than open market purchase.


19-38
                        Going Public
       A firm “goes public” when it offers common
        stock to the public for the first time in its life.
           Initial Public Offering (IPO)
       Subsequent issues of common stock are called
        “seasoned” issues.
       Underwriters try to price the IPO issue at 10%
        to 15% below the expected trading price.




19-39
        For Sale, but not on Ebay




                           3,500,000 shares
                                  Ebay, Inc.
                              Common stock
                     Initial Public   Underwriting Proceeds to
                      Par Price
                     Offeringvalue   $0.01 per share
                                         Discount   Company
         Per share     $18.00            $1.26        $16.74




19-40
                Going Private
     A small group of investors purchase the
      entire common equity of a publicly
      traded firm.
     Firm is no longer subject to SEC
      reporting requirements.
     Substantial transaction cost involved in
      going public or going private.



19-41
        Advantages of Going Public
     Raise new capital
     Achieve liquidity and diversification for
      current shareholders
     Create a negotiable instrument
     Increase the firm’s equity financing
      flexibility
     Enhance the firm’s image




19-42
        Disadvantages of Going Public
     Disclosure requirements
     Accountability to public shareholders
     Market pressure to perform short-term
     Pressure to pay dividends
     Dilution of ownership interest
     Expense of going public
     Higher estate valuation



19-43
        Features of Preferred Stock
       Hybrid securities:
         Claims senior to common stock, junior to
          debt.
         Dividends must be paid to preferred before
          they can be paid to common.
     Usually have a par or stated value.
     Dividend rate is usually specified.
     Redemption provisions:
         Optional
         Mandatory

19-44
        Financing with Preferred Stock
     Why do firms issue preferred stock?
     Sinking fund preferred is like debt:
          The “interest payments” are not tax-
           deductible, but
          This is offset by the fact that missing a
           scheduled payment does not lead to
           bankruptcy.




19-45
        Financing with Preferred Stock
       Preferred stock dividends also qualify for the
        70% dividends-received deduction when the
        preferred shareholder is another corporation.
       Because of this, preferred-stock yields are
        usually lower than the yields of comparable
        debt instruments.
       Plus, if the firm is not paying taxes currently
        due to poor operating results, the forgone
        interest tax deduction is not an issue.


19-46
        Financing with Preferred Stock
     Utility companies have been the heaviest
      issuers of fixed-rate preferred stock.
     Regulated utilities can pass the cost of
      preferred dividends through to their
      customers.




19-47
                   Summary
     There many ways to finance a firm.
     Retained earnings, bonds, and common
      stock are primary methods.
     Securities can be sold in the public
      market or privately.
     Most new issues are underwritten.
     Issuance costs are important because
      they are proportionately lower for larger
      issues.

19-48

				
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