Issuing Securities to the Public.ppt

1、DRAFT,CONFIDENTIAL,CHAPTER 1,Issuing Securities to the Public,Executive Summary,This chapter looks at how corporations issue securities to the investing public. As the basic procedure for selling debt and equity securities are essentially the same. This chapter focuses on equity.,Chapter Outline,19.

2、1 Public and Private Sources of Capital 19.2 The Public Issue 19.3 Alternative Issue Methods 19.4 The Cash Offer 19.5 The Announcement of New Equity and the Value of the Firm 19.6 The Cost of New Issues 19.7 Rights 19.8 The Rights Puzzle 19.9 Shelf Registration 19.10 The Private Equity Market 19.11

3、Summary and Conclusions,19.1 Public and Private Sources of Capital,Firms raise debt and equity capital from both public and private sources. Public Sources of Capital Capital raised from public sources must be in the form of registered securities. Securities are publicly traded financial instruments

4、. They are traded on public secondary markets, after issued on primary market. Most securities must be registered with the Securities and Exchange Commission (SEC).,Private Sources of Capital Private capital comes either in the form of bank loans or as what are know as private placements. Private pl

5、acements are financial claims exempted from the registration requirements that apply to securities. To be qualified for exemption the issue muse be restricted to a small group of sophisticated investors (fewer than 35) with minimum income or wealth requirements Privately placed financial instruments

6、 cannot be traded on public markets. Rule 144A allows institutions with assets exceeding $100 million to trade these financial claims among themselves.,Two differences between public and private sources Public issues has to be registered with SEC, while private placed issues need not. Public issued

7、securities can be publicly traded, while privately placed instruments cannot. Public markets tend to be anonymous. Investors in public markets are legally protected against inside trading. Since investors in private markets are assumed to be sophisticated who are aware of each others identities, ins

8、ide trading is not as problematic.,Advantages and Disadvantages of Private Sources,Advantages Terms of private bonds and stock can be customized for individual investors. No costly registration with SEC. No need to reveal confidential information. Easier to renegotiate. Disadvantages Limited investo

9、r base Less liquid,19.2 The Public Issue,The Basic Procedure Management gets the approval of the Board of Directors. The firm prepares and files a registration statement with the SEC. This document is required for all public issues of securities except Loans that mature within nine months Issues tha

10、t involve less than $5.0 million The SEC studies the registration statement during the waiting period. The firm may distribute copies of a preliminary prospectus.,The Basic Procedure The firm prepares and files an amended registration statement with the SEC if needed. If everything is copasetic with

11、 the SEC, a price is set and a full-fledged selling effort gets underway. A final prospectus must accompany the delivery of securities. Marketing the issue: road shows and tombstone advertisements are used during and after the waiting period.,The Process of A Public Offering,Steps in Public Offering

12、Time 1. Pre-underwriting conferences 2. Registration statements 3. Pricing the issue 4. Public offering and sale 5. Market stabilization,Several months 20-day waiting period Usually on the 20th day After the 20th day 30 days after offering,An Example of a Tombstone Advertisement,19.3 Alternative Iss

13、ue Methods,There are two kinds of public issues: The general cash offer Cash offers are sold to all interested investors. The rights offer Rights offers are sold to existing shareholders.,Classifying Equity Offerings Initial Public Offering (IPO): the first public equity issue that is made by a comp

14、any. Seasoned Offering (SEO): the new equity issue where the companys securities have been previously issued. All IPOs are cash offers. SEOs can be made by using either cash offers or rights offers Almost all debt is sold in general cash offerings.,Investment Bank,Investment banks are financial inte

15、rmediaries that perform a wide variety of services. The business of investment banks The sale of securities Facilitating mergers and other corporate reorganizations Acting as brokers to both individual and institutional clients Trading for their own accounts. Research,For corporate issuers investmen

16、t banks perform the following services: Formulating the method used to issue the securities. Pricing the new securities. Selling the new securities.,Top Global Underwriters, 1999,19.4 The Cash Offer,There are three methods for issuing securities for cash: Firm Commitment Best Efforts Dutch Auction,F

17、irm Commitment,Under a firm commitment the investment bank (or a group of bankers) buys the securities from the issuing firm for less than the offering price and sell them to the public investors. Obviously, they need to make a profit, so they buy at “wholesale” and try to resell at “retail”. Becaus

18、e this function involves risk, we say that the investment bankers underwrite the securities. Or they act as underwriters.,Spread (Discount), which is the difference between the underwriters buying price and the offering price is the basic compensation received by the underwriters. The issuer receive

19、s the full amount of the proceeds less the spread and all the risk is transferred to the underwriters. To minimize their risk, the investment bankers combine to form an underwriting syndicate to share the risk and help sell the issue to the public. The lead (principal) managers has responsibility fo

20、r all aspects of the issue.,Best Efforts,Under a best efforts underwriting, the underwriter does not buy the issue from the issuing firm. Instead, the underwriter acts as an agent, receiving a commission for each share sold, and using its “best efforts” to sell the entire issue at the agreed-upon of

21、fering price. This is more common for initial public offerings than for seasoned new issues. Why?,Dutch Auction,The underwriters do not set a fixed price for the shares to be sold. They conduct an auction in which investors bid for shares. The offering price is determined in the auction. It is also

22、called uniform price auction. This approach is relatively new in the IPO market though it is more common in the bond market.,An Example of Dutch Auction,Suppose the Rial Company wants to sell 400 shares to the public. The company receives five bids as follows:,Determine the highest price that will r

23、esult in all 400 shares being sold. In this example this price is $12 at which the demand for the shares is 500 shareholder. Successful bidders pay the same price (uniform price auction). Allocate the shares to be issued. Compute the ratio of the shares offered to shares bid at the offer price or be

24、tter, 400/500=0.8 in this case. All successful bidders receive 80 percent of the shares they bid at $12. Finally, the offering price is $12. A, B and C get 80 shares respectively, and D gets 160 shares.,Green Shoe Provision,This provision gives the members of the underwriting group the option to pur

25、chase additional shares at the offering price. It usually last for about 30 days and involve no more than 15 percent of the newly issued shares. It is a benefit to the underwriting syndicate and a cost to the issuer.,Lockups,Lockup arrangements specify how long insiders must wait after an IPO before

26、 they can sell some of their stock. It is not unusual for the number of lock-up shares to be larger than the number of shares held by the public. The stock price will drop if these shares are sold to the market.,Quiet Period,A quiet period extends from the time a company files a registration stateme

27、nt with the SEC until SEC staff declare the registration statement “effective”. (U.S. Securities and Exchange Commission) All communication with the public must be limited to ordinary announcements and other purely factual matters. The underwriters analysts are prohibited from making recommendations

28、 to the investors.,Selecting the Underwriters,There are two methods for selecting an underwriter Competitive Negotiated Negotiated deals in investment banking occur with all but the largest issuing firms.,IPO Under Pricing,The incentives of investment banks in pricing: It is prohibitively costly or

29、impossible sometimes for atomistic public investors to study and price the IPO firms themselves. Investment banks know the firms they underwrite much more than the public investors. Do they have the incentives to price the issue too high? In the long run their concerns on the “reputation capital” pr

30、event them form doing so.,IPO Under Pricing,What is observed in the real world? The first day return is the return an investor earns if she buys the new shares on the primary market at the offering price and sell them on the secondary market at the closing price on the first trading day immediately.

31、 IPO typically have been offered at 11 percent below their true market price. (Ibbotson, JFE, 1975) Average IPO rose in price 17.3 percent in the first day of trading following issuance for 7600 IPOs from 1975 through 2005 in United States.,Possible Explanation I,Fact I: under pricing tends to be at

32、tributable to firms with few or no sales in the prior year. The implication for IPO Under Pricing: Young firms are riskier in general. To attract risk averse investors, young firms have to under price their issues to compensate the investors.,Average First-Day Returns, Categorized by Sales, for IPOs

33、: 1980-2005,Possible Explanation II,Fact II: when the price of a new issue is too low, the issue is often oversubscribed. The implication for IPO under pricing (Winners Curse): Though on average IPO is under-priced, some may be overpriced. Informed investors only bid for underpriced IPO, while uninf

34、ormed investors bid for all IPO. In equilibrium, uninformed investors are more likely to get shares for overpriced IPO and less likely for underpriced IPO. To attract uninformed investors firms have to under-price their issues to compensate their information disadvantage.,Other Explanations,To reduc

35、e their risk of as underwriters, investment banks have the incentive to underprice the issues. To attract investors in later issuing, the firms are willing to underprice their IPOs at the first place. The IPO firms are overvalued at the first trading day. Investors buy the shares of IPO firms on the

36、 secondary market on the first trading day earns an average return of 5 percent per year over a period of 5 years (Loughran and Ritter, 1995).,19.5 The Announcement of New Equity and the Value of the Firm,What is the price effect of the existing equity if a firm announce a new seasoned equity offeri

37、ng? Should the price of existing equity go up because new positive NPV projects are undertaken? The market value of existing equity drops on the announcement of a new issue of common stock.,Possible Explanations,Managerial Information Since the managers are the insiders, perhaps they are selling new

38、 stock because they think it is overpriced. Debt Capacity If the market infers that the managers are issuing new equity to reduce their debt-equity ratio due to the specter of financial distress the stock price will fall. Falling Earnings,19.6 The Cost of New Issues,Spread or underwriting discount O

39、ther direct expenses Indirect expenses Abnormal returns (SEO) Underpricing (IPO) Green Shoe Option,Direct Costs as a Percentage of Gross Proceeds for IPO Offered by US Companies: 1990-2003,Direct Costs as a Percentage of Gross Proceeds for SEO Offered by US Companies: 1990-2003,Direct Costs as a Per

40、centage of Gross Proceeds for Straight Bonds Offered by US Companies: 1990-2003,Some Features of Direct Cost,Economy of Scale: the costs for both equity offerings and debt offerings decline as the gross proceeds of the offering increase. Direct costs are higher for equity offers than for debt offers

41、. Why? The direct costs (gross spread plus underpricing) of going public for the first time is substantially high. So it is a weighty decision for firms.,19.7 Rights,An issue of common stock to existing stockholders is called a rights offering. Each shareholder is issued an option to buy a specified

42、 number of new shares from the firm at a specified price within a specified time. The rights are often traded on securities exchanges or over the counter. This allows shareholders to maintain their percentage ownership if they so desire.,Mechanics of Rights Offerings,The management of the firm must

43、decide: The price existing shareholders must pay for new shares. How many rights will be required to purchase one new share of stock. What effect will the rights offering have on the existing price of the stock.,Rights Offering Example,National Power earns $2 million after taxes and has 1 million sh

44、ares outstanding. Earnings per share are $2, and the stock sells at 10 times earnings (PE ratio is 10). The market price of each share is therefore $20. The market value of the firm is then $20 million. The company plans to raise $5 million of new equity funds by a rights offering.,Subscription Pric

45、e,Subscription Price (exercise price) is the price that existing shareholder are allowed to pay for a share of stock. A rational shareholder will subscribe to the rights offering only if the subscription price is below the market price of the stock on the offers expiration date. To attract sharehold

46、ers to exercise the rights and obtain the funds in general the subscription price is set below the current market price of the stock. Assume in this example National Power choose a price of $10, which is far below the market price, $20.,Number of Rights Needed to Purchase a Share,Shareholders typica

47、lly get one right for each share of stock they own, 1 million rights will be issued by National Power.,Shareholders must give up two rights plus $10 to receive a share of new stock.,Effect of Rights Offering on Price of Stock,When stock price of National Power is $20 on the expiration day, all inves

48、tors will exercise the rights and buy new shares of the company at $10 per share. After rights offering the value of the firm is $25 million and the shares outstanding is 1.5 million. The ex-rights stock price is then $25/1.5=$16.67 per share.,Value of Rights,Any investor with 2 rights can buy 1 sha

49、re of National Power which is worth $16.67 per share after rights offering at a price of $10. The value of 2 rights is clearly $16.67-$10=$6.67, which means $3.33 for 1 right.,Effects on Shareholders Wealth,What can an investor do with National Powers rights offering if she owns 2 shares of the comp

50、any? Exercise the rights and buy 1 new share of the company. Do not exercise and sell the rights. Do not exercise and let the rights expire.,If (1) occurs, the investor owns 3 shares. The total wealth of the investor is $16.67 * 3 = $50, which equals $20 * 2 + $10. If (2) occurs, the investor owns 2

51、 shares. The total wealth of the investor is $16.67 * 2 + 6.67 = 40, which equals $20 * 2. If (3) occurs, the investor owns 2 shares. The total wealth of the investor is $16.67 * 2 = $33.33, which is less than $40,The Underwriting Arrangement,Undersubscription can occur if the stock price falls belo

52、w the subscription price. Rights offerings are typically arranged by standby underwriting. The underwriter makes a firm commitment to purchase the unsubscribed portion of the issue at the subscription price less a take-up fee.,19.8 The Rights Puzzle,Over 90% of new issues are underwritten, even thou

53、gh rights offerings are much cheaper. A few explanations: Underwriters increase the stock price. There is not much evidence for this, but it sounds good. The underwriter provides a form of insurance to the issuing firm in a firm-commitment underwriting. The proceeds from underwriting may be available sooner than the proceeds from a rights offering. The successful rights offering depends