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


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

  1. 1. Investment Banking Public and Private Placement 15
  2. 2. Chapter Outline <ul><li>What is investment banking? </li></ul><ul><li>Functions of an investment banker. </li></ul><ul><li>Advocacy on matters of mergers and acquisitions. </li></ul><ul><li>Public versus private financing. </li></ul><ul><li>Leveraged buyouts and debt for restructuring of a corporation. </li></ul>
  3. 3. The Role of Investment Banking <ul><li>The link between the corporations in need of funds and the investor. </li></ul><ul><ul><li>Responsible for designing and packaging a security offering. </li></ul></ul><ul><ul><li>Responsible for selling the securities to the public. </li></ul></ul>
  4. 4. Concentration of Capital <ul><li>Allows large firms to take additional risks and satisfy the needs of an increasingly demanding capital market </li></ul><ul><ul><li>Competition has propelled many businesses to the position they are at now. </li></ul></ul><ul><ul><li>Raising capital has become an international proposition. </li></ul></ul><ul><ul><li>Firms that are very large have the ability to compete. </li></ul></ul><ul><ul><li>International consolidations with international buy-outs of banks have become common. </li></ul></ul>
  5. 5. Underwriters, Markets, and Rankings
  6. 6. Gramm-Leach-Bliley Act (1999) <ul><li>Repealed the separation policy of the Depression-era laws. </li></ul><ul><ul><li>Which included separating banking, brokerage, insurance and investment banking into separate entities. </li></ul></ul><ul><li>Federal Reserve and Treasury: </li></ul><ul><ul><li>Have the power to impose restrictions on the activities of the banks. </li></ul></ul><ul><ul><li>Allows strong banks to participate in the venture capital market. </li></ul></ul>
  7. 7. Investment Banking Competitors <ul><li>There is intense competition the market. </li></ul><ul><ul><li>Being a leader in one sector helps a firms overall reputation. </li></ul></ul><ul><ul><li>It however does not ensure success in other areas. </li></ul></ul>
  8. 8. Underwriter <ul><li>An investment banker underwrites any risk associated with a new issue: </li></ul><ul><ul><li>By giving a ‘firm commitment’ to purchase the securities from the corporation. </li></ul></ul><ul><li>Large investment houses assume risk of distribution. </li></ul><ul><li>Smaller investment houses may handle distributions for unknown corporations. </li></ul><ul><ul><li>This is done on a “best effort” basis or commission basis. </li></ul></ul>
  9. 9. Market Maker <ul><li>Investment banker engaged in buying and selling of the security to ensure a liquid market. </li></ul><ul><ul><li>Provides research on the firm to encourage active investor interest. </li></ul></ul>
  10. 10. Advisor <ul><li>Services offered include advising the client on a continuing basis about: </li></ul><ul><ul><li>The types of securities to be sold. </li></ul></ul><ul><ul><li>The number of shares or units for distribution. </li></ul></ul><ul><ul><li>The timing of the sale are some of the services offered. </li></ul></ul><ul><li>Important advisory services in the area of mergers, leveraged buyouts and corporate restructuring are also offered. </li></ul>
  11. 11. Agency Functions <ul><li>An investment banker may act as an agent for a corporation. </li></ul><ul><ul><li>That wishes to place its securities privately with: </li></ul></ul><ul><ul><ul><li>An insurance company, </li></ul></ul></ul><ul><ul><ul><li>A pension fund, or </li></ul></ul></ul><ul><ul><ul><li>A wealthy individual. </li></ul></ul></ul><ul><ul><li>Involves in negotiation of the best possible deal for the corporation with potential investors. </li></ul></ul>
  12. 12. Distribution Process in Investment Banking
  13. 13. The Spread <ul><li>The underwriting spread represents the total compensation for all participating members. </li></ul><ul><ul><li>The lower a party falls in the distribution process, the higher the price for the shares. </li></ul></ul><ul><ul><li>The farther down the line of securities are resold, the higher the potential profit. </li></ul></ul><ul><ul><li>The larger the dollar value of an issue, the smaller the spread is as a percentage of the offering price. </li></ul></ul>
  14. 14. Allocation of Underwriting Spread
  15. 15. Pricing the Security <ul><li>Investment Banker </li></ul><ul><ul><li>Price of the stock is an important consideration </li></ul></ul><ul><ul><li>Conduct an in-depth analysis to determine a firms value: </li></ul></ul><ul><ul><ul><li>The company’s industry. </li></ul></ul></ul><ul><ul><ul><li>Financial characteristics. </li></ul></ul></ul><ul><ul><ul><li>Anticipated earnings. </li></ul></ul></ul><ul><ul><ul><li>Dividend-paying capability. </li></ul></ul></ul>
  16. 16. Pricing the Security (cont’d) <ul><li>Based on a technique deemed appropriate by the underwriter: </li></ul><ul><ul><li>A tentative price is assigned. </li></ul></ul><ul><ul><li>This will compared to others in that given industry. </li></ul></ul><ul><ul><li>Anticipated public demand also plays a major factor. </li></ul></ul><ul><li>Underpricing </li></ul><ul><ul><li>Setting the price slightly below the current market value. </li></ul></ul><ul><ul><ul><li>Common during the issuance of additional shares. </li></ul></ul></ul>
  17. 17. Dilution <ul><li>Problem associated with the issuance of additional securities: </li></ul><ul><ul><li>Actual or perceived dilution of earnings effect on shares currently outstanding. </li></ul></ul><ul><ul><li>May be caused by the perceived time lag in the recovery of earning per share. </li></ul></ul><ul><ul><ul><li>Resulting from increase in shares outstanding. </li></ul></ul></ul>
  18. 18. Market Stabilization <ul><li>An investment banker is responsible for stabilizing the offering during the distribution period: </li></ul><ul><ul><li>Accomplished by repurchasing securities when market price is below initial public offering price. </li></ul></ul><ul><ul><li>Stabilization lasts for two to three days after initial offering. </li></ul></ul><ul><ul><li>Poor market environment - stabilization may be very difficult to achieve. </li></ul></ul><ul><ul><li>Underwriter price support – an exception to market manipulation. </li></ul></ul>
  19. 19. Aftermarket <ul><li>Research shows that the IPO generally tends to perform well in the immediate aftermarket. </li></ul><ul><ul><li>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. </li></ul></ul><ul><ul><li>The IPO appears to be a good deal for investors who purchase shares from the underwriter. </li></ul></ul>
  20. 20. Shelf Registration (1982) <ul><li>Permits large companies to file one comprehensive registration statement. </li></ul><ul><ul><li>Should outlines the firm’s financing plans for up to 2 years. </li></ul></ul><ul><ul><li>The firm can issue securities without further SEC approval. </li></ul></ul><ul><ul><li>This registration has become part of the underwriting process. </li></ul></ul><ul><ul><li>Most frequently used with debt issue, and utilized minimally with the equity markets. </li></ul></ul>
  21. 21. Public versus Private Financing <ul><li>Many companies, by choice or circumstance, prefer to remain private. </li></ul><ul><ul><li>They restrict their financial activities to direct dealings. </li></ul></ul>
  22. 22. Advantages of Being Public <ul><li>To the Corporation: </li></ul><ul><ul><li>Tap security markets for greater amounts of funds. </li></ul></ul><ul><ul><li>Associated prestige – better relationships. </li></ul></ul><ul><ul><li>Ability to purchase another firm using its own stock as currency. </li></ul></ul><ul><li>To the Stockholders: </li></ul><ul><ul><li>Ability to achieve a higher degree of liquidity and to diversify his or her portfolio. </li></ul></ul><ul><ul><li>Stockholders of a private corporation can sell holdings if it decides to go public. </li></ul></ul>
  23. 23. Disadvantages of Being Public <ul><li>All information must be made public through SEC and state filings. </li></ul><ul><li>Tremendous pressure for short-term performance by security analysts and large institutional investors. </li></ul><ul><li>For small firms, the underwriting spread and the out-of-pocket costs can run in to the 15-18% range. </li></ul>
  24. 24. Public Offerings - Examples <ul><li>A classical example of instant wealth – EDS goes public </li></ul><ul><li>Internet Capital Group </li></ul><ul><ul><li>Refer to the chapters for the complete story. </li></ul></ul>
  25. 25. Public Offerings – Examples
  26. 26. Internet Capital Group Stock Price (as of January 13, 2006)
  27. 27. Private Placements <ul><li>Selling of securities not through the security market but directly: </li></ul><ul><ul><li>Insurance companies. </li></ul></ul><ul><ul><li>Pension funds. </li></ul></ul><ul><ul><li>Wealthy individuals. </li></ul></ul><ul><li>Device is employed by: </li></ul><ul><ul><li>Firms who wish to avoid or defer an IPO offering. </li></ul></ul><ul><ul><li>A publicly traded company wishing to merge private funds into its financing package. </li></ul></ul>
  28. 28. Advantages of Private Placements <ul><li>No lengthy, expensive registration process with the SEC. </li></ul><ul><li>Firm has greater flexibility in negotiating than is possible in a public offering. </li></ul><ul><li>Initial costs of a private placement may be considerably lower than those of a public issue. </li></ul>
  29. 29. Disadvantages of Private Placements <ul><li>Interest rate on bonds is usually higher to compensate the investor for holding a less liquid obligation. </li></ul>
  30. 30. Going Private <ul><li>The trend: </li></ul><ul><ul><li>1970s, a number of small firms gave up their public listings to be private. </li></ul></ul><ul><ul><li>1980s and 1990s, very large companies began going private. </li></ul></ul><ul><li>Reason: </li></ul><ul><ul><li>Costs could be saved in annual report expenses, legal and auditing fees, and security analyst meetings. </li></ul></ul>
  31. 31. Methods of Going Private <ul><li>Two ways of going private: </li></ul><ul><ul><li>A publicly owned company is purchased by a private company or a private equity fund. </li></ul></ul><ul><ul><li>To repurchase all publicly traded shares from stockholders. </li></ul></ul>
  32. 32. Leveraged Buyout <ul><li>Either the management, or some other investor group borrows the needed cash to repurchase all the shares of the company. </li></ul><ul><ul><li>The company exists with substantial debt and heavy interest cost. </li></ul></ul><ul><ul><li>Management of the private company must sell assets to reduce the debt load. </li></ul></ul><ul><ul><li>Corporate restructuring occurs: </li></ul></ul><ul><ul><ul><li>Divisions and products are sold. </li></ul></ul></ul><ul><ul><ul><li>Assets redeployed into new, higher-return areas. </li></ul></ul></ul>
  33. 33. Leveraged Buyout (cont’d) <ul><li>Investment bankers, as specialists in the valuation of assets, try to determine the ‘breakup value’ of a large company. </li></ul><ul><ul><li>This is its value if all divisions were divided up and sold separately. </li></ul></ul>
  34. 34. Privatization <ul><li>Privatization involves: </li></ul><ul><ul><li>Investment bankers taking companies public. </li></ul></ul><ul><ul><li>The companies sold have been previously owned by governments. </li></ul></ul>