International Cost of Capital Day 3 Dr Michael Dowling

What we’ll look at today… Looking at some of the drivers of international investment and raising capital internationally, specifically we’ll be examining cost of capital and access to capital. Builds on EF544 cost of capital discussion.

Ryanair’s truly international financing 1996: Raise $42m from Texas Pacific Group 1997: IPO on Nasdaq and ISE to raise $160m : Opportunistic capital raising from European investors 2012: €4bn debt, mainly US but swapped into euros

In a nutshell - international financing offers …  Lower cost of capital [why did Prada choose Hong Kong IPO last year?]  Greater access to capital [Nokia - €250bn in 2000, more than Finland’s entire GDP]  Combined :[how familiar would Irish investors have been with airline investing in 1997?]

Cost of Capital - a look at WACC and CAPM

The Cost of Capital  When a firm identifies and undertakes and investment project that generates a return exceeding its cost of capital, the firm’s value will increase  Aim is to identify highest return projects and/or lowest cost capital Cost of capital is the minimum rate of return an investment project must generate in order to pay its financing costs

Weighted Average Cost of Capital (WACC)

Example of WACC

Lowering WACC  A firm that can lower its WACC will have a greater selection of possible projects to choose from, as the hurdle rate will be lower  Lowering WACC strategies:  Take on more debt because of tax advantages, but bankruptcy risk and lack of corporate flexibility  Persuade investors to accept a lower return on equity or banks to accept lower interest rates  Market securities to a wider group of investors and lenders internationally

Global capital seeking and lower cost of capital in theory…

Why would cost of capital be cheaper in an international marketplace?

A bit more on K e : The Capital Asset Pricing Model (CAPM)

Just a bit more on beta and diversifiable vs non-diversifiable risk

Unique risk and global diversification

Two impacts of international diversification Lower expected return Investors will face lower systematic risk due to world market being more diversified than local market so will need lower returns from investment Lower required return Companies will as a result not be expected to generate as high returns compared to a segmented national capital market

Some evidence: King and Segal [2008]  Canadian firms have lower valuations compared to similar US firms  This means they have a higher cost of capital. Why does lower value imply higher cost of capital?  The valuation difference disappears when the firms cross-list on both US and Canadian stock markets

Does cost of capital differ among countries?  Short answer; yes, by a significant degree  Long answer; well, we’re not 100% sure as we don’t quite have an accurate measurement method, but yes it does differ… b91a375dfd.html

But large liquid markets aren’t that different: real after-tax cost of funds in US and UK Source: Robert McCauley and Steven Zimmer, “Exchange Rates and International Differences in the Cost of Capital” in Y. Amihud and R. Levich, Exchange Rates and Corporate Performance (Irwin 1994) UK U.S.

Do multinational companies always have a lower WACC?

Novo Industri A/S  Popular case of a Danish multinational that sought to internationalize its capital structure by accessing foreign capital markets  Novo Industri is a Danish industrial enzyme and pharmaceutical firm  In 1977 the management sought to tap in to other capital markets because the Danish market was illiquid and segmented causing Novo to incur a higher cost of capital than that of its international competitors

Novo Industri A/S  The Danish equity markets had at least six factors of market segmentation  Asymmetric information for Danish and foreign investors  Taxation  Alternative sets of feasible portfolios  Financial risk  Foreign exchange risk  Political risk

Novo Industri A/S  Asymmetric information  Denmark had a regulation that prohibited Danish investors from holding foreign private sector securities  This left little incentive for Danish investors to seek out new information or follow developments in other markets  Another barrier was the lack of equity analysts in Denmark following Danish companies

Novo Industri A/S  Taxation  Danish taxation policy charged a capital gains tax of 50% on shares held for over two years  Shares held for less than two years were taxed at a marginal income tax rate as high as 75%  This led to bonds being the security of choice among Danes  Feasible set of portfolios  Because of the prohibition on foreign security ownership, Danish investors had a limited set of securities from which to choose  Danish stocks offered international investors an opportunity to diversify, but not the reciprocal for Danish investors

Novo Industri A/S  The Road to Globalization  When Novo’s management decided to access foreign equity markets in 1977 they had several barriers to overcome  Closing the information gap: Novo now needed to begin disclosing their financials in accordance with international standards  In 1979 Novo had a successful Eurobond issues which lead to more disclosure and international recognition among investors

Novo Industri A/S  The Road to Globalization  During 1979, Novo also listed its convertibles on the London Stock Exchange (LSE)  Also during that year there was a big boom in biotechnology and Novo went to the US to sell investors on their company  The road show worked and Novo’s shares on the Danish exchange and the LSE rose in price from increased demand  This prompted Novo to consider an equity issue in the US

Novo Industri A/S  The Road to Globalization  During the first half of 1981 Novo prepared an SEC registration  Before the offering over 50% of Novo’s shareholders had become foreign investors  On May 30, 1981 Novo listed in the NYSE and although it had lost 10% of its value in Copenhagen the previous day, the $61 million offering was a success and the share price quickly gained all its losses from the previous day

Novo’s B-Share Prices Compared with Stock Market Indices