1. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. Chapter 16: Investment Banking and the Public Sale of Equity Securities Corporate Finance, 3e Graham, Smart, and Megginson

2. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. 2 Investment banks assist companies in selling new securities. Companies that raise capital externally can issue debt or equity. Securities can be sold through private placements or to the public. First public offering is known as an IPO. Subsequent offerings are known as SEOs. Overview of Global Investment Banking

3. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. League Table  The data reveal how sharply the volume of worldwide corporate security offerings dropped during 2008: from a record $7.602 trillion during 2007 to $4.697 trillion in 2008  In sharp contrast to almost all recent years, U.S. investment banks did not dominate the underwriting league table.  Bulge bracket firms generally occupy the lead or co- lead manager’s position in large new security offerings

4. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. Key Investment Banking Activities  Corporate finance  Trading  Asset management

5. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. Investment Banks’ Role in Equity Offerings 5 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

6. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. Investment Banks’ Role in Equity Offerings 6 Public security issues can be: Best efforts 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 U.S. security offerings are underwritten this way. Direct negotiated offerCompetitive bidding Firms can choose an investment bank through:

7. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. Investment Banks’ Role in Equity Offerings 7 Securities offerings are usually handled by a syndicate of many investment banks. One of these banks is usually named the lead underwriter, or book-runner. Other leading banks are called co-managers.

8. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. Investment Banks’ Role in Equity Offerings 8 Best-efforts offering Bank promises to sell firm’s securities, but makes no guarantee it will be for firm’s offering price Firm-commitment offering Bank guarantees (underwrites) the offering price

9. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. Services Provided by Investment Bankers and Their Costs 9 Investment banks provide services prior to security offering. Prior to offering, lead investment bank negotiates underwriting agreement.

10. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. Services Provided During and After a Security Offering 10 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 may engage in price stabilization after offering. After offering, lead underwriter serves as principal market maker.

11. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. Table 16.5 Key Steps in the IPO Process  Initial Step  Selecting book-runner and co-manager  Letter of intent  Registration Process  Registration statement and due diligence  Red herring  Marketing  Distribute prospectus  Road show  Pricing and Allocation  Aftermarket Activities  Stabilization; overallotment option  Research coverage 11

12. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. Legal Rules Governing U.S. Public Security Sales 12 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.

13. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. Basic Disclosure Documents  Actually a series of registration statements, beginning with the preliminary prospectus  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. 13 Principal disclosure document: Registration Statement Prospectus Supplemental Disclosures

14. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. 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 out of inventory (off the shelf) over the next two years.  Popular with issuers; very flexible 14 SEC introduced Rule 415: shelf registration Most qualifying debt and equity issues are shelf registered.

15. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. Benefits of an IPO 15 IPO can raise large amounts of new capital for growth. Publicly traded stock is currency for acquisitions. Listed stock (options) can be used to attract top managers. Provides personal wealth and liquidity for entrepreneur Serves as advertising for firm and its products/services Research suggests IPO stocks earn normal long-term returns

16. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. Drawbacks of an IPO 16 High financial costs of IPOs, with no guarantee of success. Cash expenses of IPO often approach $1 million. Managerial costs of planning and executing IPO Need to focus on stock price and deal with shareholders Severe constraints on managerial discretion in public firm

17. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. Types of Specialized IPOs 17 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

18. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. Seasoned Equity Offerings (SEO) 18 SEOs infrequent for most U.S. and non-U.S. firms Reason Negative market reaction when SEOs are announced SEO announcements convey negative info: Short-term and long-term performance of SEOs: prices fall on announcement, underperform over 1-5 years.

19. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. Rights Offerings 19  Existing shareholders have the right to buy new shares at a discount or can sell this right to other investors.  Rarely done today by large American companies, but still common in other countries

20. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. Private Placements in the U.S. 20 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”

21. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. International Common Stock Offerings 21 Two types Domestic stock offering International, or cross-border, issues Total number and value of non-U.S. IPOs exceeds U.S. total. All markets show significant IPO underpricing. Unclear whether international IPOs underperform in the long run. Most markets also seem prone to hot and cold markets.

22. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. International Common Stock Offerings  Many of the same investment anomalies are common to both U.S and international markets:  non-U.S. private-sector IPOs also demonstrate significant first-day returns.  initial international offers also may yield negative long-term returns.  popular non-U.S. issues also tend to be heavily oversubscribed  hot-issue markets are as prevalent internationally as in the United States.  taxation issues (particularly capital gains tax rules) affect how issues are priced and/or which investors the offers are targeting. 22

23. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. American Depositary Receipts (ADRs) 23 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

24. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. Privatization’s Impact on Stock Market Development  A government executing a share issue privatization (SIP) sells all or part of its ownership in a state-owned enterprise to private investors via a public share offering.  27 of the 30 largest share offerings in history were SIPs.  Positive long-run excess returns to investors who purchase SIPs  Government allocates shares mainly to employees and other small domestic investors. 24