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Sourcing Equity Globally

Sourcing Equity Globally

To implement the goal of gaining access to global capital markets a firm must begin by designing a strategy that will ultimately attract international investors. This would mean identifying and choosing alternative paths to access global markets. This would also require some restructuring of the firm, improving the quality and level of its disclosure, and making its accounting and reporting standards more transparent to potential foreign investors.

Designing a Strategy to Source Equity Globally

Designing a capital sourcing strategy requires that management agree upon a long-run financial objective and then choose among the various alternative paths to get there.

Often, this decision making process is aided by an early appointment of an investment bank as an official advisor to the firm.

Designing a Strategy to Source Equity Globally

Most firms raise their initial capital in their own domestic market. However, most firms that have only raised capital in their domestic market are not well known enough to attract foreign investors. Incremental steps to bridge this gap include conducting an international bond offering and/or cross-listing equity shares on more highly liquid foreign stock exchanges.

Designing a Strategy to Source Equity Globally

Depositary receipts (depositary shares) are negotiable certificates issued by a bank to represent the underlying shares of stock, which are held in trust at a foreign custodian bank. American depository receipts (ADRs) are certificates traded in the United States and denominated in US dollars. ADRs are sold, registered, and transferred in the US in the same manner as any share of stock with each ADR representing some multiple of the underlying foreign share (allowing for ADR pricing to resemble conventional US share pricing between $20 and $50 per share).

Mechanics of American Depositary Receipts (ADRs)


Shares
American Depositary Receipts issued by a bank representing underlying shares held by a custodial bank

Receipts (ADRs)

Publicly traded firm outside the U.S.

Receipts for shares listed on U.S. exchange

Traded by U.S. investors

Shares

Shares traded on local stock exchange

Arbitrage Activity
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Arbitrage with Depository Receipts

There are some stocks which are also allowed to be bought in India and converted into the DR forms, which is attractive if the DR is trading at a premium to the Indian stock price. The Process 1. Buy DR 2. Sell local stock in India in cash market or futures market. 3. Convert shares from DR to local. 4. Deliver shares to stock exchange in India. 5. Deposit proceeds in Indian bank account. 6. Repatriate funds. 7. Repeat process.
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Designing a Strategy to Source Equity Globally

ADRs can be exchanged for the underlying foreign shares, or vice versa, so arbitrage keeps foreign and US prices of any given share the same after adjusting for transfer costs. ADRs also convey certain technical advantages to US shareholders. While ADRs are quoted only in US dollars and traded only in the US, Global Registered Shares (GRSs) can be traded on equity exchanges around the globe in a variety of currencies.

Indian Depository Receipts

The rapid technological developments have made it possible for speedier transfer of money and securities. Sweeping technological advances and the rapid growth of e-commerce have made conventional, geographic, regulatory and market barriers irrelevant.

Indian Depository Receipts

A number of Indian companies have accessed the global markets by ADR/GDR route with a view to raising the foreign exchange for their global operations. With the projected growth rate of the Indian economy at 8% and the spurt in the forex markets, India is fast emerging as an important destination for global companies.

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Indian Depository Receipts

IDRs is an innovative instrument enabling overseas corporates to raise funds through the Indian capital markets. It would enable the Indian investors to invest in well performing companies and participate in the growth and prosperity of these companies. It would provide one more investment instrument to the Indian investors and this increases the choice of instruments available to them.

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Indian Depository Receipts

The IDR would be an instrument denominated in Indian Rupees and represented by underlying securities of the foreign company, which are listed on an international stock exchange. IDRs would be listed on the Indian stock exchanges in the similar manner in which GDRs and ADRs issued by domestic companies are listed overseas.

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Indian Depository Receipts

The foreign company would raise funds from Indian investors by floating IDRs and issue the securities underlying the IDRs to an overseas custodian bank, which, in turn, authorize the domestic depository bank in India to issue IDRs to Indian investors.

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Structure of IDR

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Depository Receipts of Indian Companies

Many Indian companies have accessed the global equity market primarily for establishing their image as global companies. Other relevant considerations are : 1.Visibility and post-issue considerations related to investor relations, 2.Liquidity of the stock (or instruments based on the stock such as depository receipts which are listed and traded on foreign stock exchanges) 3.The price at which the issue can be placed, costs of issue and factors related to taxation.
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Shares of many firms are traded indirectly in the form of depository receipts e.g. GDR and ADR . After a hesitant start in 1992 following the experience of the first ever GDR issue by an Indian company , a fairly large number of them have raised equity capital in international markets.

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Indian companies in the ADR/GDR market

Company ($m) Arvind Mills Ashok Leyland Century Textiles Crompton Dr. Reddys GE Shipping Indian Hotels Indo Gulf ICICI Infosys L&T Mah&Mah Reliance Satyam Infoway VSNL Wipro

Industry Textiles Auto Diversified Electrical Pharma Shipping Hotels Fertilizers Finance IT Diversified Auto Diversified IT Telecom IT

Date of Issue Feb-1994 Mar-1995 Sep-1994 Jul- 1996 Jul-1994 Feb-1994 Apr-1995 Jan-1994 Sep-1999 Mar-1999 Mar-1996 Nov-1993 May-1992 Oct-1999 Mar-1997 Sep-2000

Size 125 138 100 50 48 100 86 100 315 70 135 75 150 75 527

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Foreign Equity Listing and Issuance

A firm must choose one or more stock markets on which to cross-list its shares and sell new equity. Just where to go depends mainly on the firms specific motives and the willingness of the host stock market to accept the firm.

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Foreign Equity Listing and Issuance

Cross-listing attempts to accomplish one or more of many objectives:

Improve the liquidity of its existing shares and support a liquid secondary market for new equity issues in foreign markets

Increase its share price by overcoming mis-pricing in a segmented and illiquid home capital market
Increase the firms visibility Establish a secondary market for shares used to acquire other firms Create a secondary market for shares that can be used to compensate local management and employees in foreign subsidiaries
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Effect of Cross-Listing and Equity Issuance on Share Price

Cross-listing may have a favorable impact on share price if the new market values the firm or its industry more than the home market does. It is well known that the combined impact of a new equity issue undertaken simultaneously with a cross-listing has a more favorable impact on stock price than cross-listing alone. Even US firms can benefit by issuing equity abroad as increased investor recognition and participation in the primary and secondary markets results.

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Barriers to Cross-Listing and Selling Equity Abroad

There are certainly barriers to cross-listing and/or selling equity abroad. The most serious of these includes the future commitment to providing full and transparent disclosure of operating results and balance sheets as well as a continuous program of investor relations. The US school of thought is that the worldwide trend toward requiring fuller, more transparent, and more standardized financial disclosure of operating results and balance sheet positions may have the desirable effect of lowering the cost of equity capital.

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Alternative Instruments to Source Equity in Global Markets (in the USA)

Alternative instruments to source equity in global markets include the following:

Sale of a directed public share issue to investors in a target market Sale of a Euroequity public issue to investors in more than one market (foreign and domestic markets) Private placements under SEC Rule 144A Sale of shares to private equity funds

Sale of shares to a foreign firm as part of a strategic alliance

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Alternative Instruments to Source Equity in Global Markets

A directed public share issue is defined as one that is targeted at investors in a single country and underwritten in whole or in part by investment institutions from that country. The issue might or might not be denominated in the currency of the target market. The shares might or might not be cross-listed on a stock exchange in the target market.

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Alternative Instruments to Source Equity in Global Markets

The gradual integration of the worlds capital markets and increased international portfolio investment has spawned the emergence of a very viable Euroequity market. A firm can now issue equity underwritten and distributed in multiple foreign equity markets, sometimes simultaneously with distribution in the domestic market. The Euro market (a generic term for international securities issues originating and being sold anywhere in the world), was created by the same financial institutions that had previously created an infrastructure for the Euronote and Eurobond markets.
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Alternative Instruments to Source Equity in Global Markets

One type of directed issue with a long history as a source of both equity and debt is the private placement market. A private placement is the sale of a security to a small set of qualified institutional buyers. Since the securities are not registered for sale to the public, investors have typically followed a buy and hold policy.

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Alternative Instruments to Source Equity in Global Markets

Private equity funds are usually limited partnerships of institutional and wealthy individual investors that raise their capital in the most liquid capital markets. These investors then invest the private equity fund in mature, family-owned firms located in emerging markets. The investment objective is to help these firms to restructure and modernize in order to face increasing competition and the growth of new technologies.
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Alternative Instruments to Source Equity in Global Markets

Strategic alliances are normally formed by firms that expect to gain synergies from one or more of the following joint efforts:

Sharing the cost of developing technology Gaining economies of scale or scope Financial assistance (lowering of cost of capital through attractively priced debt or equity financing)

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