Chapter 20 Issuing Securities to the Public

8/10/2019 Chapter 20 Issuing Securities to the Public

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Dr. Xiao Ming USTB 1

Chapter 20Chapter 20Issuing Securities to the PublicIssuing Securities to the Public

University of Science and Technology BeijingUniversity of Science and Technology Beijing

Dongling School of Economics and managementDongling School of Economics and management

Dec 2012


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Key Concepts and Skills

Understand how securities are sold to the public and the

role of investment bankers

Understand initial public offerings and the costs of

going public

Understand the venture capital market and its role in

financing new businesses


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4/34Dr. Xiao Ming USTB 4

20.1 The Public Issue

The Basic Procedure

Management gets the approval of the Board.

The firm prepares and files a registration statementwith the SEC.

The SEC studies the registration statement during thewaiting period.

The firm prepares and files an amended registration

statement with the SEC.

If everything is copasetic with the SEC, a price is setand a full-fledged selling effort gets underway.



The Process of a Public Offering

Steps in Public Offering Time

1. Pre-underwriting conferences2. Registration statements3. Pricing the issue4. Public offering and sale5. Market stabilization

Several months20-day waiting period

Usually on the 20th dayAfter the 20th day

30 days after offering



An Example of a Tombstone



20.2 Alternative Issue Methods

There are two kinds of public issues:

The general cash offer

The rights offer

Almost all debt is sold in general cash offerings.



Table 20.2 - I



Table 20.2 - II


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20.3 The Cash Offer

There are three methods for issuing securities for cash:

Firm Commitment

Best Efforts

Dutch Auction

There are two methods for selecting an underwriter

Competitive

Negotiated


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Firm Commitment Underwriting

The issuing firm sells the entire issue to theunderwriting syndicate.

The syndicate then resells the issue to the public.

The underwriter makes money on the spread between

the price paid to the issuer and the price received frominvestors when the stock is sold.

The syndicate bears the risk of not being able to sell theentire issue for more than the cost.

This is the most common type of underwriting in theUnited States.


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Best Efforts Underwriting

Underwriter must make their best effort to sell the

securities at an agreed-upon offering price.

The company bears the risk of the issue not being sold.

The offer may be pulled if there is not enough interest at

the offer price. The company does not get the capital,and they have still incurred substantial flotation costs.

This type of underwriting is not as common as it used to be.


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Dutch Auction Underwriting

Underwriter accepts a series of bids that include numberof shares and price per share.

The price that everyone pays is the highest price thatwill result in all shares being sold. There is an incentive to bid high to make sure you get in

on the auction but knowing that you will probably pay alower price than you bid.

The Treasury has used Dutch auctions for years. Google was the first large Dutch auction IPO.


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20.4 What CFOs Say

Firms go public for two primary reasons:

Raise capital

Create a publicly traded asset

Benefits of the public market seem to be the more

important reason: Use shares for future acquisitions

Allow owners to diversify holdings Enhance reputation

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20.5 The Announcement of New Equity andthe Value of the Firm

The market value of existing equity drops on theannouncement of a new issue of common stock.

Reasons include Managerial Information

Since the managers are the insiders, perhaps they areselling new stock because they think it is overpriced.

Debt Capacity

If the market infers that the managers are issuing newequity to reduce their debt-equity ratio due to the specter offinancial distress, the stock price will fall.

Falling Earnings


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20.6 The Cost of New Issues

1. Spread or underwriting discount2. Other direct expenses

3. Indirect expenses4. Abnormal returns5. Underpricing6. Green Shoe Option


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The Costs of Equity Public Offerings

Proceeds Direct Costs Underpricing(in millions) SEOs IPOs IPOs

2 - 9.99 2.88% 15.36% 18.18%10 - 19.99 8.81% 11.63% 10.02%20 - 39.99 7.24% 9.81% 17.91%

40 - 59.99 6.20% 9.21% 29.57%60 - 79.99 5.81% 8.65% 39.20%80 - 99.99 5.56% 8.34% 45.36%100 - 199.99 5.00% 7.67% 37.10%200 - 499.99 4.26% 6.72% 17.72%500 and up 3.64% 5.15% 12.19%`


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Mechanics of Rights Offerings

The management of the firm must decide:

The exercise price (the price existing shareholders must pay

for new shares).

How many rights will be required to purchase one new share

of stock. These rights have value:

Shareholders can either exercise their rights or sell their

rights.


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Rights Offering Example

Popular Delusions, Inc. is proposing a rights offering.

There are 200,000 shares outstanding trading at $25

each. There will be 10,000 new shares issued at a $20subscription price.

What is the new market value of the firm? What is the ex-rights price?

What is the value of a right?


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What is the new market value of the firm?

shares20$

shares000,10share

25$shares000,200000,200,5$ +=

There are 200,000outstanding shares at

$25 each.

There will be 10,000 newshares issued at a $20

subscription price.


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What Is the Ex-Rights Price?

Thus, the value of a right is:

$0.2381 = $25 $24.7619


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20.8 The Rights Puzzle

Over 90% of new issues are underwritten, even thoughrights 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 issuingfirm in a firm-commitment underwriting.

The proceeds from underwriting may be available soonerthan the proceeds from a rights offering.

No single explanation is entirely convincing.


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20.9 Dilution

Dilution is a loss in value for existing shareholders:

Percentage ownership shares sold to the general public

without a rights offering Market value firm accepts negative NPV projects

Book value and EPS occurs when market-to-book valueis less than one

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20.10 Shelf Registration

Permits a corporation to register an offering that itreasonably expects to sell within the next two years.

Not all companies are allowed shelf registration. Qualifications include:

The firm must be rated investment grade. They cannot have recently defaulted on debt.

The market capitalization must be > $75 m.

No recent SEC violations.

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20.11 The Private Equity Market

The previous sections of this chapter assumed that a

company is big enough, successful enough, and old

enough to raise capital in the public equity market.

For start-up firms and firms in financial trouble, the

public equity market is often not available.


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Private Placements

Private placements avoid the costly procedures

associated with the registration requirements that are a

part of public issues. The SEC typically restricts private placement issues to

less than one hundred qualified investors, includinginstitutions such as insurance companies and pension

funds.

The biggest drawback is that the securities cannot be

easily resold.

V t C it l


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Venture Capital

The limited partnership is the dominant form ofintermediation in this market.

There are four types of suppliers of venture capital:1. Old-line wealthy families

2. Private partnerships and corporations

3. Large industrial or financial corporations have establishedventure-capital subsidiaries.

4. Individuals, typically with incomes in excess of $100,000and net worth over $1,000,000. Often these angels havesubstantial business experience and are able to tolerate highrisks.

Corporate Equity Security Offerings


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Corporate Equity Security Offerings

17.7%

16.2%

66.1%

Private Rule 144A placements

Private non-Rule 144A placements

Public equity offering

Source: Jennifer E. Bethal and Erik R. Sirri, Express Lane or TollBooth in the Desert: The Sec of Framework for Securities Issuance,

Journal of Applied Corporate Finance (Spring 1998).

S f Fi i


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Stages of Financing

1. Seed-Money Stage

2. Start-Up

3. First-Round Financing

4. Second-Round Financing

5. Third-Round Financing

6. Fourth-Round Financing


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Chapter 20 Issuing Securities to the Public

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