CHAPTER 19

Initial Public Offerings, Investment Banking, and Financial Restructuring

Differentiate between a private placement and a public offering.

In a private placement, securities are sold to a few investors rather than to the public at large.

In a public offering, securities are offered to the public and must be registered with SEC.
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Why would a company consider going public?

Advantages of going public

Current

stockholders can diversify. Liquidity is increased. Easier to raise capital in the future. Going public establishes firm value. Makes it more feasible to use stock as employee incentives. Increases customer recognition.

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Disadvantages of Going Public

Must

file numerous reports. Operating data must be disclosed. Officers must disclose holdings. Special deals to insiders will be more difficult to undertake. A small new issue may not be actively traded, so market-determined price may not reflect true value. Managing investor relations is timeconsuming.

Describe how an IPO would be priced. Since the firm is going public, there is no established price. Banker and company project the companys future earnings and free cash flows The banker would examine market data on similar companies.

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Price set to place the firms P/E and M/B ratios in line with publicly traded firms in the same industry having similar risk and growth prospects. On the basis of all relevant factors, the investment banker would specify a range in the preliminary prospectus.

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What is a roadshow?
Senior management team, investment banker, and lawyer visit potential institutional investors Management cant say anything that is not in prospectus, because company is in quiet period.

What is book building?

Investment banker asks investors to indicate how many shares they plan to buy, and records this in a book. Investment banker hopes for oversubscribed issue. Based on demand, investment banker sets final offer price on evening before IPO.

What are typical first-day returns?

For 75% of IPOs, price goes up on first day. Average first-day return is 14.1%. About 10% of IPOs have first-day returns greater than 30%. For some companies, the first-day return is well over 100%.

There is an inherent conflict of interest, because the banker has an incentive to set a low price: to make brokerage customers happy. to make it easy to sell the issue. Firm would like price to be high. Note that original owners generally sell only a small part of their stock, so if price increases, they benefit. Later offerings easier if first goes well.

What are equity carve-outs?

Also known as partial PO or spin-out A special IPO in which a parent company creates a new public company by selling stock in a subsidiary to outside investors. Parent usually retains controlling interest in new public company.

What is a Rights Offering?

A rights offering occurs when current shareholders get the first right to buy new shares. Shareholders can either exercise the right and buy new shares, or sell the right to someone else. Wealth of shareholders doesnt change whether they exercise right or sell it.

What is meant by Going Private?

Going private is the reverse of going public. Typically, the firms managers team up with a small group of outside investors and purchase all of the publicly held shares of the firm. The new equity holders usually use a large amount of debt financing, so such transactions are called leveraged buyouts (LBOs).

Advantages of Going Private

Gives managers greater incentives and more flexibility in running the company. Removes pressure to report high earnings in the short run.

After several years as a private firm, owners typically go public again. Firm is presumably operating more efficiently and sells for more.

How do companies manage the maturity structure of their debt?

Maturity matching
Match

maturity of assets and debt

Information asymmetries
Firms

with strong future prospects will issue short-term debt

Under what conditions would a firm exercise a bond call provision?

If interest rates have fallen since the bond was issued, the firm can replace the current issue with a new, lower coupon rate bond.
However, there are costs involved in refunding a bond issue. For example,
The

call premium. Flotation costs on the new issue.

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The NPV of refunding compares the interest savings benefit with the costs of the refunding. A positive NPV indicates that refunding today would increase the value of the firm.

However, it interest rates are expected to fall further, it may be better to delay refunding until some time in the future.