RAISING CAPITAL

AND ISSUING
SECURITIES TO
PUBLIC - IPO
By: M Zahid Khan
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NEW ISSUES

Flotation is the initial offering of securities to

the public.

Primary issues used to:

convert from a private company to a public
company;
spin-off a portion of the business of a listed
company;
form a new public company;
privatize a public organization.
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ADVANTAGES OF PUBLIC COMPANY LISTING

Access to additional capital.

Increased negotiability of capital.
Growth not limited by cash resources.
Enhancement of corporate image.
Can attract and retain key personnel.
Gain independence from a spin-off.

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DISADVANTAGES OF PUBLIC COMPANY LISTING

Dilution of control of existing owners.

Additional responsibilities of directors.
Greater disclosure of information.
Explicit costs.
Insider trading implications.

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SECONDARY ISSUES
Private placements - securities are offered and sold
to a limited number of investors who are often the
current major investors in the business.

Rights issues - issue of shares made to all existing

shareholders, who are entitled to take up the new
shares in proportion to their present holdings.
Determined by:
amount of funds required by the company;

the market price of the companys securities;

general economic conditions;

nature of the company shareholders.

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UNDERWRITING
Firm underwriting
A guarantee that funds will be made available to a
company at a specific time on agreed terms and
conditions.
Standby underwriting
Where the bidding company has insufficient cash
in a successful bid or if cash is offered as an
alternative to a share bid.
Best efforts underwriting
Underwriter must use best efforts to sell the
securities at the agreed offering rate.

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UNDERWRITING FEES

Underwriters fee is a reflection of:

size of the issue
issue price
general market conditions
market attitude towards shares
time period required for underwriting

Fees also include brokerage and

management fees.
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PRICING A NEW ISSUE
Done with the assistance of an underwriter.
Fixed price offer - Price is fixed in advance.
Open price offer - Price is determined at
the end of the offer period.
Constrained open price offer - Price is
determined at the end of the offer period but
places an upper and lower price between
which all bids will be considered.
Underpricing - Issuing securities at a price
below their true value.
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NEW EQUITY SALES
RESEARCH FINDINGS

Shares prices tend to decline after a new

equity issue announcement, but rise
following a debt announcement.

Why?
management has superior information about firm
value
excessive debt usage
substantial issue costs

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THE COST OF ISSUING
SECURITIES

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RIGHTS OFFERINGS: BASIC
CONCEPTS
Rights offering
Issue of ordinary shares to existing shareholders.
Subscription price
The dollar cost of one of the shares to be issued.
Ex-rights date
Beginning of the period when shares are sold
without a recently declared right, normally four
trading days before the holder-of-record date.
Holder-of-record date
Date on which existing shareholders are
designated as the recipients of share rights.

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EX RIGHTS SHARE PRICES
Rights-on Ex-rights

Announcement Ex-rights Record

date date date

September 30 October 13 October 15

Rights-on
price
$20.00 $3.33 =Value of a right
Ex-rights
price
$16.67

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THEORETICAL RIGHTS PRICE

M -S
n
nr
where:

n number of shares held to obtain a right

M market price
S subscription or issue price of the rights issue
r number of additional shares offered

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RIGHTS ISSUE EXAMPLE

Lemon Co currently has 5 million shares on

issue with a market price of $8 each. To
finance new projects, the company needs to
raise an additional $6 million. To raise the
finance, the company makes a rights issue at
a subscription price of $6 per share.

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RIGHTS ISSUE EXAMPLE
The number of new shares to be sold:
funds to be raised

subscription price
$6 000 000

$6
1 000 000 shares
The holder of one right is entitled to subscribe to one new
share at $6 per share.
To issue 1 million shares, the company would have to issue
1 million rights.
The company has 5 million shares on issue, which means
that for every 5 shares held, a shareholder is entitled to
receive one right (1-for-5 rights issue).

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RIGHTS ISSUE EXAMPLE
Calculate the theoretical rights price:
m -S
n
nr
$8 - $6
5
5 1
$1.67
If an outsider buys a right, it will cost $1.67.
The right can be exercised at a subscription price of
$6.
Total cost = $1.67 + $6 = $7.67.

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THE VALUE OF RIGHTS
Initial position No. of shares 5 million
Share price $8
Value of firm $40 million
Terms of offer Subscription price $6
No. new shares issued 1 million
After issue No. of shares 6 million
Value of firm $46 million
Share price $7.67
Value of right per share $0.33
Value of a right $1.65

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NEW ISSUES AND DILUTION
Dilution
Loss in existing shareholders value in terms of either
ownership, market value, book value or EPS.

Types of dilution
Dilution of proportionate ownership - a shareholders
reduction in proportionate ownership due to less-than-
proportionate purchase of new shares.
Dilution of market value - loss in share value due to use
of proceeds to invest in negative NPV projects.
Dilution of book value and earnings per share (EPS) -
reduction in EPS due to sale of additional shares.

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NEW ISSUES AND DILUTION

THANK YOU

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