HYBRID RICE CORPORATION

Case 1
Situation and Problem:

The Directors of Hybrid Rice Corporation want to modernize its plant and machinery by
making a public issue of shares. They wish to approach the stock exchange, while the finance
manager prefers to approach a consultant for the new public issue of shares. The problem is to
know which is better to approach first between a consultant and the exchange. After that, the
method to issue share in which the capital will be obtain shall also be determined.

Alternatives:

o Market
New public issue of shares occurs in the primary market which is done by
companies who wants to raise fund due to insufficient internally generated funds to meet
the need for a new project or expansion. Issuing shares or securities that are not previously
existing in any exchange is done in the primary market. To put simply, it is the market
where new securities are created and are sold to public for the first time.
Primary market is said to be part of the capital market that deals with the issuance
or sale of securities that are equity-backed to investors directly. In which, capital market is
the market where long-term securities – debt or equity- are traded. Primary market in
relation to capital market functions for the capital formation. Also, it helps investors to
invest in a company or enterprise starting new projects or with the purpose of expansion of
the company.
o Stock Exchange vs. Consultant
➢ Stock Exchange
A stock exchange is a facility where brokers and traders can buy and sell securities.
It is a marketplace where stocks and bonds are being sold and bought. It allows company
to raise capital while supporting the investors with informed decision. Additionally, it acts
an agent of the economy by facilitating trade and disseminating information.
It can either be a primary market or secondary market. It serves as a primary market
when companies or enterprise are able to raise funds by channeling funds from savers into
productive ventures. On the other hand, it serves as a secondary market when investors are
able to sell their securities to other investors in exchange for cash.

Functions Benefits Drawbacks

Liquidity and Marketability Creation of market for Increased accountability to

company shares. public issue.

Price Determination Enhanced company Need to maintain dividend

financial status and and profit growth trend
standing.
Safety Increased public awareness Adhering strictly to the
and interest for the rules and regulation of the
company. governing bodies.

Economic Contribution Acquisition opportunities. Loss of privacy.

Equity spread and

Speculation

➢ Financial Consultant

Consultant works with clients for developing individualized financial plans for
savings, retirement, investment, and insurance. They work for either the company or
individual in making plans for financial future while offering information and guidance
covering tax, investment, as well insurance decisions. Additionally, consultant can
facilitate the trading of securities for their clients. They usually meet the clients first to
assess the situation before making any recommendation. Also, they offer a variety of
services such a financial planning, guiding insurance decisions, and identifying suited
investments.

The cost of hiring a consultant depends on the needs of the clients. Other have fixed
rates but other may charge higher than the fixed rate. One of the basis of the fee they
charge is the portfolio being managed by them. With regards to this, consultant charge
 0.99% of the portfolio they manage. The fee can either be lump sum or annually or
monthly paid. In United States, for a comprehensive plan, clients are normally charge
$1000 to $2000. On the other hand, in the Philippines, the charge is typically between
P 5 000.00 to P 30 000.00 or an annual rate of 1% to 2% of the clients net worth.

The requirements for hiring a consultant are the following:

1. Bachelor’s Degree
2. License or Certification

Functions Benefits Drawbacks

Assessment of financial Broader and deeper Cost

situation. knowledge on money
management.
Financial Planning, Advice Reduction of financial Challenge to find one.
and Strategies stress
Preparation and Experience and Investment Conflict of Interest
Interpretation of Financial Education
Documents
Monitoring changes in Saving Time
financial status and life
circumstances.

o Primary Market Issue

➢ Private Placement

Private Placement occurs when issuer is looking for a single investor, institutional
buyer or group of buyers to purchase the whole securities issued. Shares or securities are
sold two or more institutional brokers which will then sell it to the market - its clients or
associates. The timeline for completing a private placement will vary based on the size
and credit profile of each issuer as well as the specific private placement lender, however,
it generally takes 6-8 weeks to complete the first transaction.
 Advantages:
1. allow an issuer to avoid the time and expense of registering with the SEC
2. process of underwriting the security is faster
3. can sell a more complex security to accredited investors who understand the
potential risks and rewards
4. the firm can remain a privately owned company
5. avoids the need to file annual disclosures with the SEC

Disadvantages:

1. higher rate of interest

2. investor may demand a higher percentage of ownership
3. smaller capital
4. limited investors
5. risky with lower liquidity
6. difficult to execute

➢ IPO (Initial Public Offering)

Initial Public Offering is also known as going public that happens when the company
sells share of stock to the public for the purpose of raising capital. It is either an offer for
sale or subscription to the general public. This method enables a company to raise funds
from a large number of investors widely scattered throughout the country. An initial
public offering (IPO) refers to the process of offering shares of a private corporation to
the public in a new stock issuance.

IPO is handled by investment bank which acts as the underwriter of the stock of the
company that are initially offered. Shares offered in this method are usually purchased by
large institutional investors. Most commonly, these institutional investors are pension
funds or mutual funds companies.
 The process to go public via initial public offering (IPO) or Direct Public Offering
(DPO) follows a prescribed path. While some elements can be handled simultaneously,
there are a number of parts that must be done sequentially. As a result, it will often take
between six and nine months for a private company to go public.

Advantages:

1. Benefit of an underwriting firm

2. Publicity and Credibility
3. Overall cost reduction
4. Stock as a mean of payment

Disadvantages:

1. Subject to more scrutiny than private placement

2. Market Pressure
3. Additional regulations
4. Loss of control

Decision:

In order to raise capital, the Hybrid Rice Corporation can either hire a consultant to assess
the situation or approach the stock market. The consultant will assess the corporation’s situation
and give other options or recommendations as to how it may raise additional capital for its
modernization project. However, approaching a consultant can result to additional cost charged to
the corporation. In case of Hybrid rice Corporation, as their purpose is to issue public shares, they
can approach the stock exchange directly. As the process in approaching the stock exchange,
especially for company or enterprise going public requires hiring an investment bank, the
corporation can make use of the services it offered.
Execution:

Private Placement

Step 1: Deal Launch. The issue is offered to investor to purchase, wherein the decision
must be made in a specific date.

Step 2: Negotiations. Terms and issuance parameters are negotiated as well solidification
of legal documents.

Step 3: Information Gathering. The due diligence of investor to the company is executed.
It includes financial statements review, researching management, and studying
companies future opportunities.

Step 4: Risk Analysis. Investor establishes a view of company’s credit quality through
factor analysis. The factors includes competitive position, company size, profitability,
leverage, and cash flows.

Step 5: Pricing. The economic terms of the deal are finalized.

Step 6: Rate Lock. Finalizing of maturity, payment schedule, and closing date.

Step 7: Closing. Transfer of shares and capital from company to investors and vice versa.

Initial Public Offering

Step 1: Select an investment bank. Investment bank advise the company on its IPO and provides
underwriting services. The criteria in selecting an investment bank are as follows:

• Reputation
• The quality of research
• Industry expertise
• Distribution i.e. if the investment bank can provide the issued securities to more
institutional investors or to more individual investors.
• Prior relationship with the investment bank
Step 2: Due diligence and regulatory filings. Under the underwritings services offered by the
investment, the investment bank does not only act as a broker between the company and
potential investors but also helps in selling initial set of shares issued.

The following underwriting arrangements are available to the issuing company:

• Firm Commitment:
• Best Efforts Agreement
• Syndicate of Underwriters

An underwriter must draft the following documents:

✓ Engagement Letter: A letter of engagement typically includes:

1. Reimbursement clause: This clause mandates that the issuing company must cover
the all out-of-the-pocket expenses incurred by the underwriter, even if the IPO is
withdrawn during the due diligence stage, the registration stage, or the marketing
stage.
2. Gross spread/underwriting discount: Gross spread is arrived at by subtracting the
price at which the underwriter purchases the issue from the price at which they sell
the issue.

✓ Letter of Intent: A letter of intent typically contains the following information:

1. The underwriter’s commitment to enter an underwriting agreement with the issuing

company
2. A commitment by the issuing company to provide the underwriter with all relevant
information and thus, fully co-operate in all due diligence efforts.
3. An agreement by the issuing company to provide the underwriter with a 15%
overallotment option.

*The letter of intent does not mention the final offering price.
 ✓ Underwriting Agreement: The letter of intent remains in effect till the pricing of the
securities, after which the Underwriting Agreement is executed. Thereafter, the
underwriter is contractually bound to purchase the issue from the company at a specific
price.
✓ Registration Statement: The registration statement consists of information regarding the
IPO, the financial statements of the company, the background of the management, insider
holdings, any legal problems faced by the company, and the ticker symbol to be used by
the issuing company once listed on the stock exchange. The SEC requires that the issuing
company and its underwriters file a registration statement after the details of the issue
have been agreed upon. The registration statement has two parts:

• The Prospectus – this is provided to every investor who buys the issued security
• Private filings – this comprises information which is provided to the SEC for
inspection but is not necessarily made available to the public

The registration statement ensures that investors have adequate and reliable information about
the securities being important. The SEC then carries out due diligence to ensure that all the
required details have been disclosed correctly.

✓ Red herring document: In the cooling off period, the underwriter creates an initial
prospectus which consists of the details of the issuing company, save the effective date
and offer price. Once the red herring document has been created, the issuing company
and the underwriters market the shares to public investors. Often, underwriters go on road
shows (called the dog and pony shows – lasting for 3 to 4 weeks) to market the shares to
institutional investors and evaluate the demand for the shares.

Step 3: Pricing. The offer is decided by the company and underwriter on the day before the
effective date as well as the precise number of shares to be sold.

The following factors affect the offering price:

• the success/failure of the road shows (as recorded in the order books)
• the company’s goal
 • condition of the market economy

*IPOs are often underpriced to ensure that the issue is fully subscribed/ oversubscribed
by the public investors, even if it results in the issuing company not receiving the full value of its
shares.

Step 4: Stabilization. The underwriter carries out after-market stabilization in the event of order
imbalances by purchasing shares at the offering price or below it. Stabilization activities can only
be carried out for a short period of time – however, during this period of time, the underwriter
has the freedom to trade and influence the price of the issue as prohibitions against price
manipulation are suspended.

Step 5: Transition to Market Competition.

The final stage of the IPO process, the transition to market competition, starts 25 days after the
initial public offering, once the “quiet period” mandated by the SEC ends.

During this period, investors transition from relying on the mandated disclosures and prospectus
to relying on the market forces for information regarding their shares. After the 25-day period
lapses, underwriters can provide estimates regarding the earning and valuation of the issuing
company. Thus, the underwriter assumes the roles of advisor and evaluator once the issue has
been made.