SK

SKEMA Bus ine s s School

TOPIC 5 – EQUITY MARKETS
HOW CORPORATIONS ISSUE
SECURITIES
REFERENCE


“Corporate Finance” by Hillier, 4th

Chapter 15
Topics Covered

• Venture Capital
• The Initial Public Offering
• Alternative Issue Procedures for IPOs
• Security Sales by Public Companies
o Rights Issue
• Private Placements and Public Issues
Venture Capital
Venture Capital

Steps to obtaining venture funding:

3. Receive subsequent
staged financing

2. Receive first-stage
financing

1. Prepare a
business plan
Venture Capital

Venture Capital
Money invested to finance a new firm

o Success of new firm dependent on managers

o Restrictions placed on management by venture capital
company
o Funds usually dispersed in stages after certain level of
success
Venture Capital

First Stage Market Value Balance Sheet ($mil)

Assets Liabilities and Equity
Cash from new equity 1.0 New equity from venture capital 1.0
Other assets 1.0 Your original equity 1.0
Value 2.0 Value 2.0
Venture Capital

Second Stage Market Value Balance Sheet ($mil)

Assets Liabilitie s and Equity
Cash from new equity 4.0 New equity from 2nd stage 4.0
Fixed assets 1.0 Equity from 1st stage 5.0
Other assets 9.0 Your original equity 5.0
Value 14.0 Value 14.0
U.S. Venture Capital Investments
Initial Offering
Initial Public Offering (IPO) - First offering of stock to the
general public
Underwriter - Firm that buys an issue of securities from a
company and resells it to the public
Spread - Difference between public offer price and price paid
by underwriter
Prospectus - Formal summary that provides information on an
issue of securities
Underpricing - Issuing securities at an offering price set
below the true value of the security
Motives For An IPO
Underwriter Spread

Spread - the difference between the public

offer price and the price paid by underwriter

Example
Assume the issuing company incurs $1 million in
expenses to sell 3 million shares at $40 each to an
underwriter; the underwriter sells the shares at $43
each. What is the spread for this deal?
Underwriting Arrangements

• Firm Commitment - Underwriters buy the

securities from the firm and then resell them to the
public
• Best Efforts Commitment - Underwriters agree to
sell as much of the issue as possible but do not
guarantee the sale of the entire issue
• Flotation Costs - The costs incurred when a firm
issues new securities to the public
o What are some of the specific costs incurred when a firm
issues new securities?
Underwriting Arrangements
Example
How much will a firm receive in net funding from a firm
commitment underwriting of 250,000 shares priced to
the public at $40 if a 10% underwriting spread has been
added to the price paid by the underwriter? Additionally,
the firm pays $600,000 in legal fees.

Cost to public = $40

Net to issuer = $40/1.10 = $36.36
Therefore, the spread was $3.64 per share
Net to issuer = 250,000 × $36.36 = $9,090,000
Less: Legal fees 600,000
$8,490,000
Underpricing of an IPO

Underpricing: Issuing securities at an offering price set

below the true value of the security.

Example
Assume the issuer incurs $1 million in other expenses to
sell 3 million shares at $40 each to an underwriter and the
underwriter sells the shares at $43 each. By the end of the
first day’s trading, the issuing company’s stock price had
risen to $70. What is the total cost of underpricing?

Cost of underpricing:
3 million($70 − $43) = $81 million
The Top Managing Underwriters
January – June 2014
 Average Initial IPO Returns
Russia Argentina
Austria Canada
Denmark Chile
Norway Netherlands
Turkey Spain
Egypt France
Mexico Portugal
Nigeria Poland
Belgium Israel
Mauritius Italy
Hong Kong U.K.
U.S. Finland
Series1
South Africa Philippines
New Zealand Cyprus
Ireland Australia
Pakistan Iran
Germany Tunisia
Indonesia Singapore
Sweden Switzerland
Brazil Morocco
Sri Lanka Thailand
Bulgaria Taiwan
Japan Greece
Malaysia Korea
India China
0 50 100 150 200 250
Jordan Saudi Arabia
Return (percent)
IPO Proceeds

IPO Proceeds and First Day Returns

IPO Netflix Inc.
IPO Proceeds and First Day Returns
IPO Netflix Inc.
IPO Proceeds and First Day Returns
IPO Netflix Inc.
Price performance
IPO Netflix Inc.
Corporate actions: stock splits and additional
offerings
Security Sales by Public Companies

General Cash Offer - Sale of securities open to all investors

by an already public company
Seasoned Offering - Sale of securities by a firm that is already publicly
traded
Shelf Registration - A procedure that allows firms to file one registration
statement for several issues of the same security

International Security Issues- Sale of securities in other

countries
Eurobond – Bonds underwritten by a group of international banks and
offered simultaneously to investors in a number of countries
Global bonds – Bonds where one part is sold internationally in the
eurobond market and the remainder sold in the company’s domestic market
Underwriting Spreads
Total Direct Costs of Raising Capital
Rights Issue

Rights Issue - Issue of securities offered only to

current stockholders.

Example
Ivanhoe Mines needs C$1.2 billion of new equity.
Market price C$24.73. Ivanhoe Mines decides to
raise additional funds by offering the right to buy 3
new shares for 20 at C$13.93 per share. With 100%
subscription, what is value of each right?
Rights Issue
Example - Ivanhoe Mines needs C$1.2 billion of new equity. Market
price C$24.73. Ivanhoe Mines decides to raise additional funds by
offering the right to buy 3 new shares for 20 at C$13.93 per share.
With 100% subscription, what is value of each right?

• Current market value = 20 × C$24.73 = C$494.60

• Total shares = 20 + 3 = 23
• Amount of new funds = 3 × C$13.93 = C$41.79
• New share price = (41.79 + 494.60) / 23 = C$23.32
• Value of a right = C$23.32 - C$13.93 = C$9.39
Rights Issue

A Slightly More Difficult Example

Lafarge Corp needs to raise €1.28billion of

new equity. The market price is €60/sh.
Lafarge decides to raise additional funds
via a 4 for 17 rights offer at €41 per share.
If we assume 100% subscription, what is
the value of each right?
Rights Issue
Example - Lafarge Corp needs to raise €1.28billion of new equity.
The market price is €60/sh. Lafarge decides to raise additional funds
via a 4 for 17 rights offer at €41 per share. If we assume 100%
subscription, what is the value of each right?

• Current market value = 17 × €60 = €1,020

• Total shares = 17 + 4 = 21
• Amount of funds = 1,020 + (4x41) = €1,184
• New share price = (1,184) / 21 = €56.38
• Value of a right = 56.38 – 41 = €15.38
Private Placements and Public Issues

Private Placement - Sale of securities to a limited

number of investors without a public offering.

Qualified Institutional Buyer – Entity entitled under

SEC Rule 144A to purchase and trade private
placements.
EXERCISES


HW8 ex 3, 5 & 14(a-b-c)