Copenhagen Business School<br />Topicsof Finance – F87<br />11-30-2010<br />GOING PUBLICTwo different approachesBookbuilding Vs. Auction<br />Pandora and Google case studies<br /> Sheila Jolin - Francesco Neri<br />David Östblad - VedranKontic<br />
TABLE OF CONTENTS<br />Introduction to IPOs<br />Pandora´s IPO<br />IPO process<br />Price setting mechanisms<br />Information asymmetry and uncertainty in IPOs<br />Bookbuilding Mechanism <br />Post-IPO activities<br />The syndicate<br />Google´s IPO<br />Dutch auction process<br />Did Google succeed?<br />Conclusions<br />
WHAT IS AN IPO?<br />INITIAL PUBLIC OFFERING<br />
An IPO is the first sale of a company’s shares to the public and the listing of the shares on the stock exchange<br />Our presentation will not focus on:<br />Seasoned equity offering (SEOs) <br />Right offerings<br />We want to focus on explaining how different options the companies have when they decide to go public for the first time – and how the different mechanisms work.<br />In both SEOs and Right Offering price is publicly available since the company is already in the market. <br />
WHY DO COMPANIES GO PUBLIC?<br />The first reason is “CASH”<br />From company perspective<br />From shareholders perspective<br /><ul><li>To get an equity capital infusion to fund new projects
To deal with the transfer of control – such as succession of the first entrepreneurial generation.
To facilitate the acquisition of the company for higher value
For private equity firms is one of the favorite exit strategies
When the government is the shareholder, IPO means privatization and cash injection</li></li></ul><li>IPOs ARE COSTLY<br /><ul><li>Direct costs</li></ul>Fees paid to lawyers, accountants, consultants and investment banks <br /><ul><li>Indirect costs:</li></ul>Increased formalization in the decision process<br />Resulting burden of disclosure requirements and compliance costs<br />Increased pressure for short-term performance<br />Underpricing<br /><ul><li>Risks</li></ul>Exposure to takeover<br />
PANDORA IN A FEW WORDS<br />Pandora designs, manufactures, markets and sells handmade jewelry all over the world. In 2009 it was one of the third largest jewellery brands in the world in term of estimated retail revenue. The company is represented in more than 40 countries across six continents. The 65% of turnover is realized outside Europe.<br />Private Equity firm<br />AXCEL acquired 60% of Pandora from<br />the Enevoldsen family<br />Established In CPH by<br />Per & Winnie Enevoldsen<br />Started manufacturing<br />In Thailand<br />New marketsUS. Germany<br />Australia<br />IPO on Nasdaq OMX<br />Copenhagen<br />2003-04<br />2008<br />2010<br />1989<br />1982<br />Generated revenue (2009) - DKK 3,5 billion (EUR 465 m)<br />EBITDA (2009) - DKK 1,6 billion<br />EBITDA Margin 45%<br />EARNINGS (2009) – € 135 m<br />Generated revenue (H1 2010) DKK 2,6 billion (EUR 345 m)<br />EBITDA (H1 2010) app. DKK 1 billion<br />Pandora A/S employs 4.500 people worldwide (3.300 in Thailand) <br />Source: Pandora<br />
PANDORA’s IPO<br />The IPO consisted of approximately 44.6 million existing shares. <br />Approximately 2.7 to 3.4 million new shares, plus 6.7 million existing shares which is an overallotment option.<br />In the end 2.9 million new shares were established. <br />Free float = 36%<br />OWNERSHIP STRUCTURE<br />Before the IPO<br />Without the Greenshoe<br />After the Greenshoe<br />Source Pandora<br />FAMILY & EMPLOYEES <br />AXCEL <br /> OTHER <br />NEW SHAREHOLDERS <br />
Institutional tranche</li></ul>The existingshareholders sold part oftheirshares<br />2,9 mof share werenewshares<br />Where?<br /><ul><li>Domestic offering
International offering</li></ul>The distinction is not related to the market of listing<br />International institutional investors<br />Retail tranche (only 5%) composed by Danish investors<br />The offering attracted strong interest from investors both in Denmark and internationally.<br />The deal was at least three times over-subscribed.<br />
ACTORS<br />Global coordinator<br />Investment Banking – Equity capital market - Sales<br />Institutional investors<br />Company shareholders<br />Syndicate of banks<br />Financial advisor<br />Specialist<br />Sponsor<br />Shareholder advisor<br />Legal counseling<br />Auditor<br />Communication department<br />Retail investors<br />Issuer / Company<br />Supervisory authority<br />SEC in the US <br />Finanstilsynet in DK <br />A company is responsible for the organization and management of the stock exchange <br />(NASDAQ OMX)<br />
<ul><li>Prospectus Presentation/Bookbulding opened – Sept. 23 2010
Investor relation activity starts</li></li></ul><li>Preparation face<br />Immediately after the decision to go public is taken, the preparation of the prospectus and the related “due diligence” begins. <br />The prospectus includes:<br />Full disclosure of the company business<br />The strategy of the company<br />Its competitive advantage<br />Quality/experience of the management<br />The use of proceeds<br />Correct representation of facts and risks <br />
Approaching The Market<br />Pre-marketing<br />The global coordinator will informally solicits institutional investors to get their “feelings” about the issue (eg. “Pilot Fishing”: with this practice the bank conducts a confidential pre-sounding of a planned IPO with some key investors).<br />Price range setting<br />The valuation will reflect the sentiment assessed during the pre-marketing step.<br />Presentation - “Roadshow”<br />The management of the issuing company and the investment bank present the issue to institutional investors in the major European centers - for larger offerings it usually takes one week in Europe and one week in the US. <br />During the roadshow period non binding bids are requested and the book is built.<br />
Going Public<br />Investors<br />Wants to make a good deal, through high yield<br />Issuer<br />Wants to maximize the proceeds<br />Opposite interests<br />The global coordinator<br />Is in between<br />Allocation of shares<br /><ul><li> Within the institutional tranche allocation is usually made on a discretionary basis.
Within the retail tranche the allocation is made on a non-discretionary basis (like pro-rata basis)</li></ul>Price setting<br />When the books are closed the bank and the issuer set the offer prize<br />
PRICE SETTING PROCESS<br />COMPANY VALUE<br />Price range for book building<br />Offering price<br />The syndicate’s tasks:<br /><ul><li> Information production
PRICE SETTING MECHANISMS <br />Open price book building<br />(Only institutional investors)<br /> Suggested price range<br />Investors are asked to provide non-binding indications of interest<br />The book is built<br /> The terms of the offering are determined according to the book<br />The syndicate underwritesthe shares:<br /><ul><li>Firm commitment
Best effort</li></ul>Fixed price<br />Offer price is set by issuer and Global Coordinator before bids are submitted <br />The Global Coordinator underwrites the offer (Firm Commitment)<br />The Global Coordinator puts its best effort to sell shares (best effort)<br />Auction<br />Investors are invited to an auction where they bid for shares<br />A market clearing price is set after bids are submitted<br />Two types of action:<br /> Price -discriminatory<br /> Uniform-price<br />Once the offer is covered, shares are allocated at a single clearing price<br />Since 1998, the US Treasury used this format to sell all of its bonds, notes and bills.<br />Key feature:<br />Allocation of shares among institutional investors is decided by the Global Coordinator on a discretionary basis <br />Key feature:<br />Allocation of shares among investors are decided on a non-discretionary basis <br />Despite the lack of transparency, it is the most common approach<br />METHOD USED BY PANDORA<br />
Setting the right price is problematic!<br />Information asymmetry<br />AUCTION<br />Winner curse risk<br />The winner risk paying too much – because the value of the asset it lower than the winner anticipated<br />OPEN PRICE-BOOKBUILDING<br />Neither the issuer nor the underwriter can know precisely what the market valuation will be. <br />Investors have no incentive to reveal positive information before the stock is sold.<br />Example: estimation of the value of an offshore oil field.<br /><ul><li> Intrinsic value = $10 m.
Bidder B estimates $20 m.</li></ul>Bidder B wins, but overpays 10 m.<br />Risk of underpricing<br />On average the closing market price on the first day of trading is higher than the offering price. This has a negative effect on the wealth of the pre-issue shareholders.<br />Shareholders leave ”money on the table”<br />
THE MARKET’S PROBLEMS WITH THE PRICING OF IPO<br />Firms that issue during low-volume periods usually experience neither high initial overpricing nor subsequent long-run underperformance<br />Monthly data<br />Cycles in both the volume and the average initial return<br />Periodof “hot issue”<br />Monthly data<br />During periods of over-optimism many firms rush to market – this could results in disappointing returns in the long term<br />Source: Ibbotson, Sindelar, Ritter (1994)<br />
The underpricing phenomenon exists in every nation with a stock market, although the amount of underpricing varies from country to country<br />
OTHERS REASONS FOR POSITIVE INITIAL RETURNS<br />What happened in <br />1999-2000?<br />Why underprice an IPO during a bubble?<br /><ul><li>Some investment banks allocated underpriced shares to specific investors in return for business
Maybe IBs did not want to take advantage of a crazy market
IPO is also a marketing event</li></ul>Source: Loughran, Ritter (2004)<br /><ul><li>Dynamic Information Acquisition Investment bankers underprice IPOs to induce regular investors to reveal information during the pre-selling period
Information Cascades Potential investors pay attention to whether other investors are purchasing
Enhancing Relation with Investors Underpriced new issues leave a good taste with investors, allowing companies to sell future seasoned offerings</li></li></ul><li>ACTORS<br />Global coordinator<br />Investment – Equity capital market - sales<br />Institutional investors<br />Company shareholders<br />Syndicate of banks<br />Financial advisor<br />Sponsor<br />Specialist<br />Legal counseling<br />Communication department<br />Retail investors<br />Shareholder advisor<br />Auditor<br />Issuer / Company<br />Supervisory authority<br />SEC in the US <br />Finanstilsynet in DK <br />A company is responsible for the organization and management of the stock exchange <br />(NASDAQ OMX)<br />
BOOKBUILDING – THE SYNDICATE<br />The Global Coordinator forms a syndicate of banks to assists in the offering<br /><ul><li>Pricing
Distribution</li></ul>The issuer selects the Global Coordinator<br />(and eventually one/more co-managers)<br />A typical syndicate is composed by three parts:<br /><ul><li>MANAGING GROUP (Global Coordinator/Book-runner and Joint Book-runner(s))</li></ul>The Book-runner is responsible for the due-diligence, roadshow, book-building, allocation and gets the largest proportion of fees .<br /><ul><li>UNDERWRITING GROUP(Managing group and non-managing underwriters).
SELLING GROUP</li></ul>The banks in the selling group put their best effort in selling the shares, but they don´t underwrite them.<br />FUNCTIONS OF THE SYNDICATE<br /><ul><li>INFORMATION – pricing is ”part art and part science”
MARKET MAKING – traders guarantee liquidity</li></li></ul><li>Price setting process<br />COMPANY VALUE<br />Pandora<br />DKK 210 per share<br />Price range for book building<br />P/E2010 = 13<br />The syndicate’s tasks:<br /><ul><li> Information production
BOOKBUILDING-PRICING<br />Information is crucial to set the price and investors have information (HARD and SOFT) that can resolve the uncertainty concerning the price.<br />The use of strategic pricing and allocation policy can offset the investors’ incentive to understate their interest in an IPO<br />A large amount of bids would be excluded<br />Just a small amount of bids would be excluded.<br />More heterogeneous group of investors<br />Demand<br />No. of share (m)<br />Underpricing is reduced<br />The expected underpricing would be much higher<br />Offer (fixed)<br />Offering Price (€)<br />Source: Forestieri (2008), Jankinson and Jones (2007)<br />A good compromise<br />For Pandora was 210 DKK<br />€ 9,1<br />€ 7,6<br />This demonstrates how the allocation among the institutional tranche on a discretionary basis works. The offering price is set not only on the basis of the intrinsic value of the issuer and the market conditions, but also on the basis of which investors the Global Coordinator wants to favor. The reward to investors consists in larger allocation of underpriced shares.<br />
How do inst. investors submit their bids?How do they provide information?<br />An Example of book<br />THREE TYPES OF BID:<br />Request of shares (or amount of money) regardless of the issue price<br />A demand schedule as a step function (partial demand curve)<br />Specifies the max. price that the bidder is willing to pay<br />Source: Iannotta (2009)<br /><ul><li>A Strike Bid doesn’t provide so much information about the demand sensibility to price
A Step Bid, by the contrary, reveals the investors’ elasticity to the offering price
Investors are allowed to revise their bid and this has a strong informational value (see Bid no.2)</li></li></ul><li>Empirical Evidences about Bookbuilding and Allocation<br />The issue price is not set according to any explicit rule, but rather based on bankers’ interpretation of investors’ indication of interest. They generally set the price at a level at which demand exceeds supply, and then allocate shares to the bidders at their discretion.<br /><ul><li> Countries that use bookbuilding typically have less underpricing than countries using fixed-price offerings
Investment bankers award more shares to bidders who reveal information through limit bids.
Bidders who participate in a large number of issues receive favorable treatment in the allocation of shares.
Investment bankers favor insurance companies and pension funds, which are usually considered long-term investors.
On average, 30% of bidders are not allocated shares.
Limit bids are favored relative to strike bids. Step bids are even more favored.
Large bidders are awarded with a larger fraction of their bids compare to small bids.
Underwriters favor high frequently bidders relative to medium-frequency bidders who are in turn favored relative to low-frequency bidders.</li></li></ul><li>PANDORA UNDERPRICING<br />Underpricing after first day = 25 %!<br />Money ”left on the table” = DKK 2,13 billion<br />Source: Datastream<br />Underpricing refers to the price run up of IPO on the first-day of trading<br />Underpricing = (First-day closing price – Offering price)/Off. Price*100%<br />Money left on the table= (First-day closing p. – Offering p.)*N° of shares<br />
STABILIZATION – THE GREENSHOE OPTION<br />STABILIZATION is “the buying of security for the limited purpose of preventing or retarding a decline in its open market price in order to facilitate it distribution to the public”<br />To assist in the stabilization effort the IB may overallot shares to investors (usually 15%)<br />The bank overallots shares creating a SHORT POSITION<br />Global<br />Coordinator<br />Issuer <br />Selling Shareholders<br />Grant an option to purchased share in the following 30 d.<br />GREEN SHOE OPTION<br />Strike Price = Offering Price<br />The option is granted for free<br />THE BANK HAS TO GIVE BACK THE SHARES BORROWED<br />2 Possible scenarios<br />
The Global Coordinator has an option to increase the issue size (no. of shares sold) in case of high demand.<br />By the contrary in case of low demand, the investment bank can decrease the issue size buying shares on the market.<br />GREENSHOE OPTION – THE TWO SCENARIOS<br />THE PRICE DROPS<br />THE IB BANK BUYS SHARES IN THE MARKET<br />hoping to reverse the fall<br />IN SUMMARY<br />Price<br /><ul><li>6,68 m additional shares (14%)
Option exercised until November 4th 2010 </li></ul>PANDORA<br />Green Shoe Option<br />210<br />The IB delivers the shares borrowed <br />THE OPTION IS NOT EXERCIZED<br /><ul><li>Option fully exercised on October 8th 2010
Profit for the IB</li></ul>Results<br />b) THE PRICE RISES<br />THE IB BANK exercises the Green Shoe Option<br />1<br />3<br />4<br />2<br />5Weeks<br />THE IB COVERS ITS SHORT POSITION WITHOUT COSTS<br />THE DEAL WAS A SUCCESS<br /><ul><li>Contrasting the price raising
SYNDICATE COMPENSATION<br />finaloffering price <br />-<br />price the membersof the syndicatepayfor the shares<br />Remunerationprovidedfor the benefit of the “management group” for the organizationof the deal<br />Differences in IPOs’ feesaround the world (Gross Spread averagevalue)<br />Management fee<br />On average 20% – 25%<br />US <br />5-7%<br />8% of Global IPO ($)<br />18% of fees<br />UK - EU<br />3 - 4,5%<br />China – India<br />0,75-1%<br />50% of Global IPO ($)<br />Only 38% of fees<br />Remunerationfor the underwriting serviceprovidedby the bankswhichguarantee the sucessof the IPO<br />Hong Kong<br />2-3%<br />Gross spread<br />100 %<br />Underwriter fee<br />On average 20% – 25%<br />The 7% spread and the 20/20/60 division are the industrystandars<br />Remunerationfor the sale service providedby the bankswhichcontribute in the allocationofshares<br />Selling fee<br />On average 50% – 60%<br />Source: Financial Times<br />
The SyndicateThe distributionofFees - Example<br />Source: Pandora<br />The Lead Manager gets 50% of the management fee, 32% of the underwriting fee and 76% of the selling concession. This is consistent with the lead manager’s considerable discretion in the allocation of sales credits.<br />Source: Torstila (2001)<br />
WHY GOING IPO IN 2004? <br />Source: Google<br />In 2004 Google expected very high performance in the coming years. <br />The launch of GMAIL to enhance the search engine.<br />To realize their vision: “organize the world's information and make it universally accessible and useful”. Google needed more resources to grow in the future. <br />Google’s owners wanted to provide employees with an option to convert their holdings in Google for cash. <br />
THE IPOS’ MARKET IN 2004<br />Source: Ritter (2009)<br /><ul><li>Google lagged behind the high-tech wave of the 1990’s. This was a period when its competitors went public in the hottest IPO period in history. At that time Google were still on the verge of ”becoming” a company.
In 2004 the financial markets started to recover from the dotcom bubble, however the number of IPOs was still low . This made even more difficult to value a new technology firm like Google. Moreover, instability in the financial markets increased downward pressure on price demanded from underwriters.</li></li></ul><li>DUTCH AUCTION, WHY? <br />Google owners being eager to maintain control of the company decisions, including the IPO. Usually Wall Street firms control the entire IPO process.<br />Google further wanted a more egalitarian IPO (i.e. that anyone can be allocated shares). The IPO process was designed to be inclusive for both small and large investors (ipo.google.com).<br />Apply disclosed and equitable allocation process at the cleaning price – Transparent price mechanism.<br />The goal was to have a share price that reflected an efficient market valuation of the company<br />Google wanted minimize the risk of underpricing, unresonable speculation, price volatility, small initial free float by the use of a Dutch Auction. <br />Even if an auction was an unusual process for an IPO in the US, they wanted lo leverage on their previous experince with auction-based advertising system.<br />Google decided to use the action process because it had waited six years until it was well established, became a household name and had a record of positive earnings.<br />The Dutch auction would have allow Google to reduce administrative fees by having a internet-based bidding process.<br />
What’s the experience with Dutch auction IPOs?<br /><ul><li> W.R. Hambrecht & Company developed an Open IPO format that was an adaptation of the modified Dutch auction with uniform price. They have administered both OpenIPOs and OpenFollowOn offering.
Some issuers have fared well in the after market and some have struggled.
Only subsequently the issuer and its bankers were allowed to reduce the offering price, notwithstanding the cleaning price determined in the auction.
April 1999 Ravenswood winery</li></ul> Clearing price = $10,50<br /> First day closing = $10,88<br /><ul><li> June 1999 Salon.com</li></ul> Clearing price = $10,50<br /> First day closing = $10<br /><ul><li>May 2002 Overstock.com</li></ul> Clearing price = $13<br /> First day closing = $13,03<br /><ul><li>December 1999 Andover.net</li></ul> Clearing price = $18<br /> First-day closing price= $78,81<br />These cases indicate that the clearing price correctly anticipated open-market valuation.<br />Despite the alleged benefits, only nine public offerings under the OpenIPO format have been completed since 1999.<br />Source: Hild (2008)<br />
DUTCH AUCTION PROCESS<br />Like in the book-building all shares will be sold at the same initial public offering price<br />
How did the Dutch auction process work?<br />Example of Google’s Master Order Book<br />Each BID should have included:<br /><ul><li> No. of shares the investor was willing to pay
Price per share the investor was willing to pay</li></ul>The auction assessed the market demand only for the Class A common stock.<br />The Clearing price is the highest price at which all the shares offered may be sold to potential investors.<br />
Example of the Pro-Rata Method <br />All investors who had submitted and not withdrawn bids with a price per share that was equal to or greater than the initial public offering price were eligible to receive an allocation of shares .<br />Successful bidders will receive share allocations on a prorata basis<br />No. shares offered<br />No. shares represented by valid bids<br />Allocation %<br />×<br />Shares Representedby Successful Bid<br />Source: GoogleAmendment No. 1 TO Form S-1 <br />
Process<br />Advantages<br />Disadvantages<br /><ul><li>Google IPO was presented as an opportunity for the masses, </li></ul>however the 5-share minimum bid empowers ”large investors”<br />The eligibilty requirements was very abstract. Some <br />underwriters required questionnaires, account amount<br />minimum of 100K and some bids rejections were unclear. <br /><ul><li>The bidders have a “professional” investor status,</li></ul>as a result bids are more informed (i.e. value of <br />security more based on fundamentals).<br />Qualification <br />Process<br /><ul><li>In Dutch auctions investors have an incentive to bid higher than fair value of stock (i.e. to secure getting stock). </li></ul>Required Informed bids and rejecting bids diminish this risk of winners curse and speculative frenzies.<br /><ul><li>In the Dutch auction the price is only determined by the demand. In case the issuer doesn´t reserve the rights to set the clearing price, the total proceeds depends greatly on the distribution of high/low bids.
The auction process required a minimum level of participation.</li></ul>Bidding and <br />auction <br />closing <br />Process<br /><ul><li>As Google decided the final clearing price and shares offered, there was a risk that its subjective view on its book/company value might have negatively influenced the price setting.
The action process usually encouraged a speculative frenzy and a distruptive backlash immediately after the start of trading.
Avoids potential underwriters discount. </li></ul>Google used an auction mechanism to gather <br />information on the value of its share. Multiple <br />revisions of price range made it possible<br />for Google to create “time-based”pricing as they<br />can adjust price in terms of current demand. <br />Pricing Process<br /><ul><li>Googles allocation system didn’t reward for </li></ul>placing high bids as the allocation of shares to successful bidders was in a equal manner.<br />No bias in deciding on who should get the shares, which can happen in the traditional approach. <br /><ul><li>No selection of investors in the allocation process can increase the risk of investors focused on short-term valuation, thus, creating strong fluctuation/disruptions on the price of share. </li></ul>Allocation <br />Process<br />
PERFORMANCE EVALUATION <br />P<br />= 50<br />E<br />A price many analysts deemed too high<br />The underpricing of 18% was very close to the average 18,8% first-day return of US IPOs during the period 1980-2001, but lower relative to other Internet IPOs, especially those that went public during the IT bubble (1999-2000).<br />The auction failed to achieve a fair market valuation for Google. However Sergey and Larry were able to maintain the control of the process (i.e. avoiding middleman in final decision making) and to create an “open IPO”. <br />The Wall Street firms co-managing the deal received less than half of their usual fees (2,8% of the revenue raised).<br />
During the first year after the IPO, Google´s stock more than triplicated.<br />The stock has never been traded below the offering price of $85<br />
CONCLUSIONS<br /><ul><li>Based on our research, we can conclude that IPO underpricing can happen regardless of whether issuers use the auction or the bookbuilding process.
Despite theory argues that the Dutch auction improves both pricing and allocation, U.S. issuers have been slow to use any auction format. Since 1999, only nine firms have used the OpenIPO format.
The features of the Dutch auction may not be benefits at all:</li></ul>Uninformed investors participate in the process<br />A minimum participation level is required in order guarantee efficiency<br />Maybe ”the highest price” strategy is not the best one in an IPO.<br /><ul><li> It seems useless to us that a company use an auction instead of a classical bookbuilding method since the issuer has the possibility to reserve the right to sell shares at below the market clearing price</li></ul>These reasons explain why the bookbuilding approach still dominates, despite the fact it is more costly and it lacks trasparency in both pricing and allocation.<br />Since an IPO is a very critical event for a company and the information asymmetry plays an important role, the intermediation of the global coordinator and the syndicate is hard to replace.<br />Finally, the bookbuilding method might be the only option that a company has in order to go public, especially in the case when the firm is not well-know. <br />The auction process can be implemented successfully in SEOs and debt offerings.<br />
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