Download 15-2

15
Investment Banking
Public and Private
Placement
Chapter
McGraw-Hill/Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
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.
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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.
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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.
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Underwriters, Markets, and Rankings
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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• Repealed the separation policy of the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.
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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.
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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.
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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.
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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.
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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.
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Distribution Process in Investment
Banking
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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.
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Allocation of Underwriting Spread
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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.
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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.
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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.
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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.
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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.
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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.
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Public versus Private Financing
• Many companies, by choice or
circumstance, prefer to remain private.
– They restrict their financial activities to direct
dealings.
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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.
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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 1518% range.
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Public Offerings - Examples
• A classical example of instant wealth – EDS
goes public
• Internet Capital Group
– Refer to the chapters for the complete story.
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Public Offerings – Examples
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Internet Capital Group Stock Price
(as of January 13, 2006)
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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.
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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.
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Disadvantages of Private Placements
• Interest rate on bonds is usually higher to
compensate the investor for holding a less
liquid obligation.
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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.
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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.
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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.
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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.
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Privatization
• Privatization involves:
– Investment bankers taking companies public.
– The companies sold have been previously
owned by governments.
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