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Topic 007

  1. 1. Chapter 15Investment Banking Public and Private Placements ByMd. Shahedur Rahaman Chowdhury 15-1
  2. 2. Chapter Outline• What is investment banking?• Functions of an investment banker• Dilution of earnings• Public versus private financing• Leveraged buyouts and debt for restructuring of a corporation 15-2
  3. 3. The Role of Investment Banking• The investment banker is the link between the corporations in need of funds and the investor – Responsible for designing and packaging a security offering – Responsible for selling the securities to the public 15-3
  4. 4. Concentration of Capital• Allows large firms to take additional risks and satisfy the needs of an increasingly demanding capital market – Competition has propelled many businesses to the position they are at now – Raising capital has become an international proposition – Firms that are very large have the ability to compete – International consolidations with international buy-outs of banks have become common 15-4
  5. 5. Gramm-Leach-Bliley Act (1999)• Repealed the separation policy of the Depression-era laws – Which included separating banking, brokerage, insurance, and investment banking into separate entities• Federal Reserve and Treasury: – Have the power to impose restrictions on the activities of the banks – Allows strong banks to participate in the venture capital market 15-5
  6. 6. Investment Banking Competitors• There is intense competition in the market – Being a leader in one sector helps a firm’s overall reputation – It, however, does not ensure success in other areas 15-6
  7. 7. Underwriter• An investment banker underwrites any risk associated with a new issue: – By giving a ‘firm commitment’ to purchase the securities from the corporation• Large investment houses assume risk of distribution• Smaller investment houses may handle distributions for unknown corporations – This is done on a “best efforts” or commission, basis 15-7
  8. 8. Market Maker• Investment banker engaged in buying and selling of the security to ensure a liquid market – Provides research on the firm to encourage active investor interest 15-8
  9. 9. Advisor• Services offered include advising the client on a continuing basis about: – The types of securities to be sold – The number of shares or units for distribution – The timing of the sale• Important advisory services in the area of mergers and acquisitions, leveraged buyouts, and corporate restructuring are also offered 15-9
  10. 10. Agency Functions• An investment banker may act as an agent for a corporation – That wishes to place its securities privately with: • An insurance company, • A pension fund, or • A wealthy individual – Involves in negotiation of the best possible deal for the corporation with potential investors 15-10
  11. 11. Distribution Processin Investment Banking 15-11
  12. 12. The Spread• The underwriting spread represents the total compensation for all participating members – The lower a party falls in the distribution process, the higher the price for the shares – The farther down the line the securities are resold, the higher the potential profit – The larger the dollar value of an issue, the smaller the spread is as a percentage of the offering price 15-12
  13. 13. Allocation of Underwriting Spread 15-13
  14. 14. Pricing the Security• Investment Banker – Price of the stock is an important consideration – Conduct an in-depth analysis to determine a firm’s value: • The company’s industry • Financial characteristics • Anticipated earnings • Dividend-paying capability 15-14
  15. 15. Pricing the Security (cont’d)• Based on a technique deemed appropriate by the underwriter: – A tentative price is assigned – This will be compared to others in that given industry – Anticipated public demand also plays a major factor• Underpricing – Setting the price slightly below the current market value • Common during the issuance of additional shares 15-15
  16. 16. Dilution• Problem associated with the issuance of additional securities: – Actual or perceived dilution of earnings effect on shares currently outstanding – May be caused by the perceived time lag in the recovery of earning per share • Resulting from increase in shares outstanding 15-16
  17. 17. Market Stabilization• An investment banker is responsible for stabilizing the offering during the distribution period: – Accomplished by repurchasing securities when market price is below initial public offering price – Stabilization lasts for two or three days after initial offering – Poor market environment - stabilization may be very difficult to achieve – Underwriter price support – an exception to market manipulation 15-17
  18. 18. Aftermarket• Research shows that the IPO generally tends to perform well in the immediate aftermarket – After the first day of trading, IPO returns are approximately 3.4% lower than returns for similar sized firms over the first full year of trading – The IPO appears to be a good deal for investors who purchase shares from the underwriter 15-18
  19. 19. Shelf Registration (1982)• Permits large companies to file one comprehensive registration statement – Should outline the firm’s financing plans for up to 2 years – The firm can issue securities without further SEC approval – This registration has become part of the underwriting process – Most frequently used with debt issues, and utilized minimally with the equity markets 15-19
  20. 20. Public versus Private Financing• Many companies, by choice or circumstance, prefer to remain private – They restrict their financial activities to direct dealings 15-20
  21. 21. Advantages of Being Public• To the Corporation: – Tap security markets for greater amounts of funds – Associated prestige – better relationships – Ability to purchase another firm using its own stock as currency• To the Stockholders: – Ability to achieve a higher degree of liquidity and to diversify his/her portfolio – Stockholders of a private corporation can sell holdings if it decides to go public 15-21
  22. 22. Disadvantages of Being Public• All information must be made public through SEC and state filings• Tremendous pressure for short-term performance by security analysts and large institutional investors• For small firms, the underwriting spread and the out-of-pocket costs can run in the 15-18% range 15-22
  23. 23. Public Offerings - Examples• A classic example of instant wealth – EDS goes public• Internet Capital Group – Refer to the chapter for the complete story 15-23
  24. 24. Public Offerings – Examples 15-24
  25. 25. Internet Capital Group Price Chart (as of January 25, 2008) 15-25
  26. 26. Private Placement• Selling of securities not through the security market but directly: – Insurance companies – Pension funds – Wealthy individuals• Device is employed by: – Firms that wish to avoid or defer an IPO offering – A publicly traded company wishing to merge private funds into its financing package 15-26
  27. 27. Advantages of Private Placement• No lengthy, expensive registration process with the SEC• Firm has greater flexibility in negotiating than is possible in a public offering• Initial costs of a private placement may be considerably lower than those of a public issue 15-27
  28. 28. Disadvantages of Private Placement• Interest rate on bonds is usually higher to compensate the investor for holding a less liquid obligation 15-28
  29. 29. Going Private• The trend: – 1970s, a number of small firms gave up their public listings to be private – 1980s, 1990s, and mid-2000s, very large companies began going private• Reason: – Costs could be saved in annual report expenses, legal and auditing fees, and security analysts meetings 15-29
  30. 30. Methods of Going Private• Two ways of going private: – A publicly owned company is purchased by a private company or a private equity fund – To repurchase all publicly traded shares from stockholders 15-30
  31. 31. Leveraged Buyout• Either the management or some other investor group borrows the needed cash to repurchase all the shares of the company – The company exists with substantial debt and heavy interest cost – Management of the private company must sell assets to reduce the debt load – Corporate restructuring occurs: • Divisions and products are sold • Assets redeployed into new, higher-return areas 15-31
  32. 32. Leveraged Buyout (cont’d)• Investment bankers, as specialists in the valuation of assets, try to determine the ‘breakup value’ of a large company – This is its value if all divisions were divided up and sold separately 15-32
  33. 33. Privatization• Privatization involves: – Investment bankers taking companies public – The companies sold have been previously owned by governments 15-33
  34. 34. EndQ 8-34
  35. 35. Q&A 8-35
  36. 36. Thank You. 8-36

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