1. Investment Banking And The Public Sale Of Equity Securities
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2. Basic Choices In Securing External Financing
A firm needing external capital faces three basic choices:
Choice of public versus private capital market
Employ an investment bank to advise and handle offering
Choice of security and type of offer: equity or debt
Focus of this chapter

3. Investment Banks Role in Equity Offerings
Asset management
Corporate finance
Trading
Investment banking lines of business
Investment banks provide advice with structuring seasoned and unseasoned issues, actual sale and post-sale services.
Seasoned offering
Equity issues by firms that already have common stock outstanding
seasoned
Unseasoned offering
Initial public offering (IPO): issue of securities that are not traded yet
unseasoned

4. Investment Banks Role in Equity Offerings
Direct negotiated offer
Competitive bidding
Firms can choose an investment bank through:
Public security issues can be:
Best
effort
The bank promises its best efforts to sell the firm’s securities. No guarantees though about the success of the offering.
Firm
commitment
Underwritten offerings, bank guarantees certain proceeds.
Vast majority of US security offerings are underwritten this way.

5. Global Investment Banking Rankings (2000), $ Billions
$11,540
$6,032
$3,497
$1,785
Top 25 banks
484 48
120
295
8. Banc of America
511 47 88 44
7. ABN Amro
1,085
626
358 60
6. Credit Suisse Group
1,163
565
493 --
5. Merrill Lynch
1,236
620
360
210
4. Citigroup
1,268
928
303 31
3. Goldman Sachs
1,283
907
344 14
2. Morgan Stanley
$1,295
$426
$297
$487
1. JP Morgan Chase
Total revenues
M&A advisory
Securities U/W and private placements
Syndicated loans
Rank & firm name
Source: Roy C. Smith, “Strategic Directions in Investment Banking – A Retrospective Analysis”

6. Services Provided By Investment Bankers And Their Costs
Investment banks provide services prior to security offering.
Primary pre-issue role: provide advice and help plan offer
Firm needing capital selects one or more lead underwriters.
Top firm the lead manager, others are co-managers
Offering syndicate organized early in process
Prior to offering, lead investment bank negotiates underwriting agreement:
Sets offer price and spread; details lock-up agreement
Bulge bracket underwriter’s spread usually 7.0% for IPOs
Initial offer price set as range; final price set day before offer.

7. Legal Rules Governing U.S. Public Security Sales
Two basic laws governing public issues:
Securities act of 1933
Prescribed security issuance procedures, set basic principle of full disclosure.
Securities and exchange commission act of 1934
Set up SEC, gave it broad regulatory, rule-making powers.
Securities laws mandate disclosure of all relevant corporate information to potential investors.
Investment banks play key disclosure role by performing due diligence.

8. Basic Disclosure Documents
Principal disclosure document: Registration Statement
Prospectus
Supplemental Disclosures
Actually a series of registration statements, beginning with the Preliminary Prospectus
Called a Red Herring after title page disclaimer (in red ink)
Statements are submitted to SEC, which responds with changes needed. Firm makes changes and resubmits.
Offering only becomes effective with SEC’s final approval.
After preliminary filing, firm and IB begin a road show.
IB does book building during road show providing key pricing info.

9. Material Covered In A Prospectus
Title page summarizes offering and lists underwriters.
Always one or more lead underwriters
First section presents offering details, discusses use of proceeds, describes firm, lists risk factors.
Inner pages detail underwriting agreement, stock ownership and if offering is primary, secondary, or mixed offering.
Sell newly issued shares
Raise new capital for the firm
Existing shareholders sell their shares
No new capital for the firm
Final page presents cold comfort letter from auditors: states that firm’s books were prepared using GAAP.

10. Shelf Registration SEC introduced rule 415: shelf registration
Qualifying issuers (more than $150 million in outstanding stock) file a “master registration statement”, summarizing planned financing for the next two years.
The company can offer securities for sale (off the shelf) over subsequent two years.
Popular with issuers; very flexible
Most qualifying debt issues are shelf registered.
Very few equity issues use shelf: IB certification needed.

11. Services Provided During And After A Security Offering
Lead underwriter sets each syndicate member’s percentage of participation.
How many shares each member must sell and compensation.
Almost all IPOs and SEOs have a green shoe option: over-allotment option to cover excess demand.
Lead underwriter is responsible for price stabilization after offering.
After offering, lead underwriter serves as principal market maker.

12. The U.S. Initial Public Offering Market
1) US IPO market is larger than rest of world’s combined.
IPOs account for 30-45% of all new equity raised each year.
2) NYSE and NASDAQ now compete for IPOs.
3) IPO market is highly cyclical: biggest IPO boom ever between 1991 and March 2000.
4) Market prone to industry “fads”: semiconductors, biotech mid-1980s; internet after 1995.
5) Institutions most important IPO investors: allocated 40-80% IPO shares.

13. Number of US IPO Offerings, Initial Returns and Gross Proceeds
$458,240
17.8%
7,054
Total
100,444
48.4
465
294,076
20.9
4,129
62,596
6.8
2,348
$1,124
5.7%
112
Gross proceeds ($ Millions)
Average first day returns (%)
Number of offerings
Period
Source: Jay R. Ritter, “Some Factoids about 2002 IPO Market”
Initial returns were very high during internet boom: 69.0% in 1999 and 55.5% in 2000.

14. Benefits Of An IPO
1) IPO can raise large amounts of new capital for growth.
2) Publicly traded stock is currency for acquisitions.
3) Listed stock (options) can be used to attract top managers.
4) Provides personal wealth and liquidity for entrepreneur
5) Serves as advertising for firm and its products/services

15. Costs Of IPO
1) High financial costs of IPOs, with no guarantee of success: cash expenses of IPO often approach $1 million.
2) Managerial costs of planning and executing IPO
3) Need to focus on stock price and deal with shareholders
4) Severe constraints on managerial discretion in public firm
Have to disclose operating and sensitive data publicly
Must follow public company governance rules set by SEC

16. Types Of Specialized IPOs
Equity carve-out
Parent sells minority stake in subsidiary to public through IPO.
Raises cash for parent, allows better monitoring of subsidiary.
Spin-off
Parent distributes all of a subsidiary’s stock to shareholders.
Full spin-off creates independent new company.
Reverse LBO
Company goes public again after LBO.
Successful LBOs create value, so high returns to second IPO.
Tracking stock
Stock mirrors performance of division, but not legally or operationally separate from parent.

17. Investment Performance Of IPOs
Patterns observed in IPO offerings:
Positive initial returns for IPO investors
Large IPOs typically underpriced less than smaller offerings.
Initial returns are higher in “hot issue markets” than in cold markets.
Mean initial returns are much higher than median: a relative handful of severely underpriced offers drive results.
Mean return overstates actual profits for most investors; uninformed investors suffer from winner’s curse.
Venture-capital backing reduced initial returns during 1980s; increased after 1990.
IPOs seem to dramatically under-perform over 1-5 years.

18. Seasoned Equity Offerings (SEO)
SEOs infrequent for most U.S. and non-U.S. firms
Reason
Negative market reaction when SEOs are announced
SEO announcements convey negative info:
Could be that managers consider stock over-valued
Could reveal that cash flows will be lower than expected
Short-term and long-term performance of SEOs: prices fall on announcement, under-perform over 1,3 and 5 years.

19. Rights Offerings
Existing shareholders have the right to buy new shares at a discount or can sell this right to other investors.
Date of record
Set by firm’s directors
Shareholders on firm’s books as of this date will receive rights.
Date when stock begins trading without right
Usually set a few days before record date
Ex rights date
Exercise price of stock being sold through offering
Right’s value depends on the number of rights needed to buy a share.
Subscription price

20. Managers have three basic decision to make in rights offer:
Rights Offerings
Managers have three basic decision to make in rights offer:
Determining amount of capital firm needs to raise
Setting subscription price: set below current market price
Determining number of rights needed to buy share of stock
Theoretically, value of right (RW) is the same whether selling separately or still attached to share.
RW = value of right
MW = market value of stock with rights
S = subscription price of stock
N = number of rights needed to buy
one share

21. Private Placements In The U.S.
Sale of a security directly to one or a group of accredited investors
Accredited investors in private placements are financially sophisticated.
Corporations, institutional investors, wealthy individuals, pension and mutual funds, venture capitalists
Rule 144A has allowed limited trading of PP among “qualified institutional investors”
qualified institutional investors
More than $100 million in assets

22. Private Placements In U.S. Capital Markets
$86
345
Rule 144A, Foreign Issuers
83.7%
75.7%
Rule 144A as % of Total PP
$263
1,282
Rule 144A, U.S. Issuers
$349
1,627
Rule 144A, All Issuers
$29
149
Yankee Private Placements
$127
699
Securitized Private Placements
$59
362
Plain Vanilla Equity
$52
214
High-Yield Debt
1,751
Straight Debt
$417
2,148
Overall Private Placements
Total Value
US$ billions
Number of Issues
Type of Offering
Source: Investment Dealers’ Digest, various 2002 issues

23. International Common Stock Offerings
Two types
Domestic stock offering
International, or cross-border, issues
Total number of non-U.S. IPOs exceeds U.S. total, but total value (except privatizations) usually much smaller.
All markets show significant IPO underpricing.
Most markets show poor long-term returns for IPOs, SEOs.
Most markets also seem prone to hot and cold markets.

24. American Depositary Receipts (ADRs)
Dollar-denominated claims issued by U.S. banks
Represent ownership of shares of a foreign company’s stock held on deposit in the issuing firm’s home country
Sponsored ADR
The issuing foreign company pays all legal and financial costs of creating and trading the security.
Issuing firm is not involved with the issue of ADRs.
Unsponsored ADR

25. Share Issue Privatizations
SIPs have raised almost $1 trillion since 1980
SIPs are 10 largest (25 of 28 largest) offers ever
13,300
Deutsche Telekom
Nov 96
14,760
Jun 00
15,000
Nippon Telegraph & Telephone
Nov 99
15,097
Feb 87
15,500
Telecom Italia
Oct 97
18,000
NTT DoCoMo
Oct 98
18,900
ENEL
22,400
Oct 88
$40,260
Nov 87
Amount ($ in millions)
Company
Date
Source: William L. Megginson and Jeffry M. Netter, “From State to Market: A Survey of Empirical Studies on Privatization”

26. Investment Banking And The Public Sale Of Equity Securities
Companies that raise capital externally can issue debt or equity.
Common stock can be sold through private placements or to the public.
First public offerings is known as IPOs. Subsequent offerings are knows as SEOs.
Investment banks assist companies in selling new securities.