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Chapter McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill ... Chapter McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill ... Presentation Transcript

  • Investment Banking Public and Private Placement 15
  • Chapter Outline
    • What is investment banking?
    • Functions of an investment banker.
    • Advocacy on matters of mergers and acquisitions.
    • Public versus private financing.
    • Leveraged buyouts and debt for restructuring of a corporation.
  • The Role of Investment Banking
    • 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.
    View slide
  • 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.
    View slide
  • Underwriters, Markets, and Rankings
  • 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    • Repealed the separation policy of the Depression-era laws.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.
  • Investment Banking Competitors
    • There is intense competition the market.
      • Being a leader in one sector helps a firms overall reputation.
      • It however does not ensure success in other areas.
  • 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 effort” basis or commission basis.
  • 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.
  • 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 are some of the services offered.
    • Important advisory services in the area of mergers, leveraged buyouts and corporate restructuring are also offered.
  • 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.
  • Distribution Process in Investment Banking
  • 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 of 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.
  • Allocation of Underwriting Spread
  • Pricing the Security
    • Investment Banker
      • Price of the stock is an important consideration
      • Conduct an in-depth analysis to determine a firms value:
        • The company’s industry.
        • Financial characteristics.
        • Anticipated earnings.
        • Dividend-paying capability.
  • Pricing the Security (cont’d)
    • Based on a technique deemed appropriate by the underwriter:
      • A tentative price is assigned.
      • This will 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.
  • 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.
  • 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 to three days after initial offering.
      • Poor market environment - stabilization may be very difficult to achieve.
      • Underwriter price support – an exception to market manipulation.
  • Aftermarket
    • Research shows that the IPO generally tends to perform well in the immediate aftermarket.
      • After the first day of trading, an 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.
  • Shelf Registration (1982)
    • Permits large companies to file one comprehensive registration statement.
      • Should outlines 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 issue, and utilized minimally with the equity markets.
  • Public versus Private Financing
    • Many companies, by choice or circumstance, prefer to remain private.
      • They restrict their financial activities to direct dealings.
  • 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 or her portfolio.
      • Stockholders of a private corporation can sell holdings if it decides to go public.
  • 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 to the 15-18% range.
  • Public Offerings - Examples
    • A classical example of instant wealth – EDS goes public
    • Internet Capital Group
      • Refer to the chapters for the complete story.
  • Public Offerings – Examples
  • Internet Capital Group Stock Price (as of January 13, 2006)
  • Private Placements
    • Selling of securities not through the security market but directly:
      • Insurance companies.
      • Pension funds.
      • Wealthy individuals.
    • Device is employed by:
      • Firms who wish to avoid or defer an IPO offering.
      • A publicly traded company wishing to merge private funds into its financing package.
  • Advantages of Private Placements
    • 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.
  • Disadvantages of Private Placements
    • Interest rate on bonds is usually higher to compensate the investor for holding a less liquid obligation.
  • Going Private
    • The trend:
      • 1970s, a number of small firms gave up their public listings to be private.
      • 1980s and 1990s, very large companies began going private.
    • Reason:
      • Costs could be saved in annual report expenses, legal and auditing fees, and security analyst meetings.
  • 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.
  • 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.
  • 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.
  • Privatization
    • Privatization involves:
      • Investment bankers taking companies public.
      • The companies sold have been previously owned by governments.