Transcript Document

10
Stock Offerings and Investor Monitoring
Other People’s Money
OPM
As a new business grows, it will at some point likely need Other
People’s Money (OPM), which could come in two forms:
1) Debt:
- loan from the bank (doubtful unless collateral is available)
- loan from a relative or a friend, credit card debt, government loans,
bonds, etc.,
- loan from the governments (e.g. Small Business Admin.)
2) Equity:
- Private equity: rich uncle, venture capitalist, hedge fund, private
equity firm (e.g. Blackstone, Cerberus, Bain) or
- Public equity: public stock offerings (min. $50m)
Venture Capitalists
 There are thousands of people with an idea who need OPM to
develop their idea. Most of these new ideas (ventures) will fail. In
fact, half of all small businesses fail in just four years. But some of
those that survive can end up being spectacularly successful (e.g.
eBay).
 Banks and other every-day sources of capital are too risk-adverse to
consider being a partner. But there are thousands of risk-tolerant
venture capital firms (also wealthy individuals called angel investors)
looking around for an above-normal return. (http://www.vfinance.com/)
 Most of the ideas presented to VCs are not marketable and will end
up in the VCs round file. The VCs get thousands of requests but are
only going to consider a few. Many times, VCs rely on an informal
network of professional friends (scientists, lawyers, accountants,
bankers, etc.) to help identify potential investments.
Venture Capitalists
 Venture capitalists face huge risks. In an effort to protect themselves,

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

VCs advance just enough money for the venture to finish the first stage
of development (e.g. prototype built). Based on the results, second stage
money is advanced to begin manufacturing, marketing and distribution.
VCs usually specialize in various stages (e.g. seed money or ground
floor vs. mezzanine or above ground floor).
To compensate for huge risks, VCs demand big returns, typically
requiring 40-60% of the equity and several seats on the board.
When a start-up selects a venture capitalist, it is important to do some
research ahead of time. Is the VC financially strong? What is the style of
the VC? (hands-on or laizze faire? flexible or bureaucratic?) What
reputation does the VC have? (check with references) What specialties
does the VC have? Does the VC have a network of contacts with special
skills? How and when will the VC “cash out” of the venture?
VCs usually don’t’ hold the investment very long – maybe 4-7 years or
until an IPO occurs.
Crowd Funding
 Crowd funding is when people pool their money, usually
via the Internet, to support a new venture
 Common examples include Internet-based organizations
that help artists (musicians, film makers, etc.) raise money
from their fans, or charities raise money for projects
 ArtistShare, Sellaband, IndieGoGo, Kickstarter, Microventures
 Global Giving, Kiva, and Wokai
 In crowd funding, people usually purchase small stakes of
equity in the venture. Consequently, the SEC is in the
process of creating finalized rules.
Venture Capitalists vs. Private Equity
 Venture capitalists usually invest in start-ups only and don’t’ hold the
investment very long – maybe 4-7 years or until an IPO occurs
 Private equity funds usually takeover a company and manage it (e.g.
www.blackstone.com, www.cerberuscapital.com,
www.baincapital.com ). Private equity managers hope to manage
their businesses so well that the businesses grow in value (i.e. sell
their stake down the road at a profit). Private equity funds often rely
heavily on debt financing.
Primary vs. Secondary Markets
Common stock = certificate
representing equity or
partial ownership in a
corporation
Issued in PRIMARY
MARKET by corporations
that need long-term funds
Stock is then traded in the
SECONDARY MARKET,
creating liquidity for
investors and company
evaluation for managers
Common Stock
 Owners of common stock vote on:
 Election of board of directors
 Authorization to issue new shares
 Amendments to corporate charter
 Other major events (ratify selection of auditors, etc.)
 Many investor assign their vote to management via a
proxy
 Individuals directly own about 25% of all common stock,
the rest is owned by institutional investors
 Owned 92% of common stock in 1950
Preferred Stock
 Represents equity or ownership interest, but usually no
voting rights, so a very passive owner
 Preferred in the sense that it gets first rights to dividends
 Heavily owned by corporate investors because of
dividend tax exemption
 Not an important source of L/T capital
Initial Public Offerings (IPOs)
 First-time sale of shares to the public
 Most common in bull market
 Typically won’t happen until a company is big
enough to sell at least $50 million of stock.
 Reasons for IPOs:
 The firm has maxed out its borrowing potential and
needs additional funds for expansion
 It’s a way for VC’s & insiders to cash in on their
investment and become millionaires overnight.
 A third but less significant reason is to make a splash in
a news and perhaps attractive the attention of future
customers
Steps in Initial Public Offerings (IPOs)
 Steps in IPO process (not necessarily
sequential):
 Get financial statements in accordance with GAAP and
have them audited.
 Meet with lawyers and talk about charter, governance,
board structure, executive compensation, etc.
 Select an investment banker
 Submit registration statement to SEC for approval.
Usually take about one month, during which the
company/bankers are barred from promoting the IPO.
(Google almost violated the quiet period rule.)
Steps in Initial Public Offerings (IPOs)
 Steps continued:
 Prepare prospectus for prospective investors (called
red herring) which is like registration statement but
more user friendly
 Road show presented to institutional investors in the
process of bookbuilding. A tombstone announcement
is prepared to advertise. Major bracket investment
banking firms are listed first (see brackets on next slide)
 Leftover shares go to individual investors
 IPO price is set and shares sold.
 Investment banker holds the firm’s hand all thru the
process for a commission on amount raised (usually
around 7%).
Tombstone
Announcement
(looks like a tombstone)
Examples of underwriters: Goldman
Sachs, Morgan Stanley, Merrill Lynch, etc.
Technically, there are no major-bracket
U.S. investment banks in existence
anymore. Bear Stearns and Lehman
Brothers went under. Merrill Lynch was
purchased by Bank of America. And
Goldman Sachs and Morgan Stanley
switched to commercial bank charters.
Initial Public Offerings (IPOs)
 Price must be set just right:
 too high – fewer shares sold, less $$ raised. If too few shares, offer
may have to be withdrawn.
 too low – all shares sold but brings in less $$.
 Underpricing is fairly common in order to increase the return to
insiders who get in on the initial IPO. This is especially the case with
smaller, more risky IPOs.
 Performance of IPOs: Price generally rises on first day (almost
20% one-day returns over last 30 years) but long-term
performance of IPOs usually is poor.
 Lockup provision (usually 6 mo.) prevents flipping and ensures
price stability. Incentive for insiders to be more truthful about
information provided before IPO.
 Underwriters can also discourage flipping by rewards nonflippers with more shares and barring flippers from future IPOs
 IPOs tend to occur more frequently during bullish stock
markets
Historical Trend of IPOs
Recent IPO Examples:
Alibaba, Sept/14, offer price $68
Facebook (FB), May/12, offer price $38
Groupon (GRPN), Nov./11, offer price $20.
LinkedIn (LNKD, May/11, offer price $45.
General Motors (GM), Nov/10, offer price $33.
Go to http://www.renaissancecapital.com/IPOHome/Rankings/BiggestUS.aspx to see largest US IPOs.
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Example of IPOs
IPO Example: Groupon (GRPN), November 4, 2011
Groupon has not been able to maintain its IPO price of $20
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Example of IPOs
IPO Example: LinkedIn (LNKD), May 19, 2011
Based on the first few days of trading, this IPO was wildly successful, given that
its offer price was only $45 per share.
Example of IPOs
General Motors (GM) IPO: November 18, 2010
General Motors became a public company again (ticker GM) on 11/18/10 by
raising $23.1 billion in the largest IPO in global history up to that point. Most of
the funds were used to pay back the government investment, bringing the
government’s ownership percentage down to about 33%. The offer price was set
at $33 per share, at which GM sold some 700 million shares. Although the price
initially rose a few dollars on the first day, the price essentially remained close
the offer price for the first couple of weeks.
IPOs (cont.)
 Abuses in the IPO market
 In 2003, regulators attempted to impose new guidelines that would
prevent abuses
 Spinning is the process in which an investment bank allocates IPO
shares to executives
 Laddering involves increasing the price above the offer price on
the first day of issue in response to substantial demand
 Excessive commissions are sometimes charged by brokers when
there is substantial demand for the IPO
Google’s IPO: Aug. 19, 2004
 Dutch Auction allows ALL investors (both individual and
institutional) to submit bids and all bids above a certain
cutoff are accepted.
 Dutch Auction resulted in more participation by noninstitutional investors (the little guy) and lower costs
(saved $20 million in fees because investment banks are
not trying to re-sell shares to investors)
 Initial price $118-135 but revised to $85
 Sold all 19.6 million shares resulting in proceeds of
$1.67b (could have raised more as price was at $100 by
end of day)
 What is it today? (ticker GOOG)
 Lot’s of flipping going on (33.3 million shares traded
during first two days)
 Google made available lots of info that could be easily
understood by everyone
Google’s IPO: Aug. 19, 2004
Public Placement of Stock
 Secondary stock offerings
 New stock issued by firm that already has shares outstanding.
Often occurs as part of restructuring efforts to achieve optimal
capital structure
 Shelf Registration
 1982 SEC rule
 Allows firms to place securities (usually within two years) without
the time lag associated with registering with SEC
Costs of IPOs
Costs of IPOs
Stock Secondary Markets
Organized Exchanges
 Execute secondary market transactions
 Examples: NYSE, AMEX, Midwest, Pacific
 NYSE is largest, controlling 80 percent of value of all organized
exchanges in the U.S.
 Used to own a “seat” on exchange in order to trade
 Used to be 1366 seats each costing $1.5m
 Now firms purchase a license to trade instead of a seat
 Trading resembles an auction
 Merged with markets in France, Belgium, and the Netherlands
 Min. requirements: Minimum # of shares, minimum revenue, earnings,
cash flow $$; share price > $1.
NYSE
Stock Secondary Markets
Over the Counter (OTC)
 No trading floor or specific location
 Telecommunications network
 Nasdaq
 National Association of Securities Dealers Automatic Quotations
 Thousands of small firms, plus high-tech giants
 OTC Bulletin Board (penny stock trading, <$1)
 Pinksheets
 Even tinier firms that do not meet requirements for NASDAQ (usually
penny stocks of fairly risky companies with OB extensions in their
tickers) Firms don’t register with SEC. Risky!!
Nasdaq Headquarters
A computer network - no trading floor –
only physical
infrastructure is
headquarter building
in Manhattan
Stock Secondary Markets
 Changes in technology
 ECN (electronic communication networks) take out
the middlemen (brokers) although still some need for
market makers and specialists
 http://batstrading.com
 Online trading has forced fees to drop substantially
 Real-time quotes in decimals
 After hours trading (crazy idea?). Allows investors to
trade on new after-hour information but not much
trading volume so poor liquidity exists
 Oodles of company info & research (much of it free)
Stock Indexes
 Dow Jones Industrial Average
 30 large U.S. firms
 Disadvantages: (1) price-weighted, (2) only 30 stocks, (3)
only represents large industrials (doesn’t represent small
companies, tech companies, etc.)
 Standard and Poor’s (S&P) 500
 Value-weighted
 500 leading U.S. firms
 Wilshire 5000 Total Mkt covers all U.S. stocks
(originally 5000 stocks traded in U.S.)
 New York Stock Exchange Indexes
 Other Stock Indexes: Amex, NASDAQ, etc.
Categorizing the Secondary Market
 In the U.S., companies and stocks are often categorized by the
following approximate market capitalization values:
 Small-cap: market cap below US$1 billion
 Mid-cap: market cap between US$1 billion and US$5 billion
 Large-cap: market cap exceeds US$5 billion
 The small-cap definition is far more controversial than those for
the mid-cap and large-cap classes. Typical values for the
ranges are enumerated here:
 Micro-cap: market cap under US$100 million
 Nano-cap: market cap under US$50 million
 Blue chip is sometimes used as a synonym for a large-cap,
while some investors consider any micro-cap or nano-cap
issue to be a penny stock, regardless of share price.
Types of Investors in Stock
 Individuals Investors
 Owned 92% of common stock in 1950
 Today, they own only 25%!
 Institutional Investors
 Today, institutional investors own about 3/4ths of common stock
outstanding
 Examples: Pension Funds, Mutual Funds, Insurance Companies,
Endowment Funds, Hedge Funds, etc.
 Hold huge voting power (CALPERS likely holds more stock than any
other single entity)
 Analysts
 Experts in certain companies who sell their ratings
 Scandalous analysts would recommend certain stocks (POS) because
of the kickback not because of a good analysis
Agency problem: investor actions
Shareholder activism
An investor who is dissatisfied with the way managers are running a firm
has three choices:
Sell
Do Nothing
Flush!
Shareholder Activism
– Proxy Fight
Corporate Actions re: Stock Value
 Mgmt is under tremendous pressure to meet
earnings targets (not given too many chances).
 Mgmt also has personal incentive to raise stock
price (stock options, etc.)
 Mgmt Responses:
 Stock repurchases to increase price & distribute cash
 LBOs options (junk bonds)
 Threat of Hostile Takeover
 Stock price decline to bargain price due to poor management
 Antitakeover amendments to charter (2/3 vote)
 Poison pills (existing owners get 25% of all new shares)
 Golden parachutes
Accounting Scandals
 Accounting irregularities
 To the extent that firms can manipulate financial
statements they may be able to hide information from
investors
 e.g., Enron, Tyco, and WorldCom
 The auditors hired to audit financial statements allowed
them to use unusual accounting methods
 Board members on the audit committee were not always
monitoring the audit
SOX 2002
 The Sarbanes-Oxley Act of 2002:
 Was implemented to ensure more accurate disclosure
of financial information to investors
 Attempts to force auditors to take their auditing role
seriously. Audit firms must register with SEC and be
“audited.” They can be punished for substandard work.
 Prevents a public accounting firm from auditing a client
whose CEO, CFO, or other employees are employed by
the client firm within one year prior to the audit
 Audit partner rotation every 5 years
SOX 2002 (cont.)
 The Sarbanes-Oxley Act:
 Requires that only outside board members of a firm be
on the firm’s audit committee
 Prevents the members of a firm’s audit committee from
receiving consulting or advising fees from the firm
 Requires that the CEO and CFO of firms to certify that
the audited financial statements are accurate
 Specifies major fines or imprisonment for employees
who mislead investors or hide evidence
 Allows public accounting firms to offer non-audit
consulting services to an audit client only if the client
pre-approves those services
 Cost of SOX to many companies >$1 million.
Stock Markets Around the World
Equity - 1.1 - Domestic market capitalization (USD millions)
December
% change /
Dec 13
(in USD)
Americas
Bermuda SE
BM&FBOVESPA
Buenos Ai res SE
Col ombi a SE
Li ma SE
Mexi ca n Excha nge
NASDAQ OMX
NYSE
Sa nti a go SE
TMX Group
Total region
1 601.5
843 894.2
60 142.0
146 745.7
78 839.9
480 245.3
6 979 172.0
19 351 417.2
233 245.5
2 093 696.8
30 269 000.0
9.2%
-17.3%
13.3%
-27.6%
-2.6%
-8.7%
14.7%
7.8%
-12.0%
-1.0%
7.0%
9.2%
-6.8%
47.1%
-10.9%
3.6%
2.7%
14.7%
7.8%
1.6%
8.0%
Asia - Pacific
Aus tra l i a n SE
BSE Indi a
Burs a Ma l a ys i a
Col ombo SE
GreTa i Securi ti es Ma rket
HoChi Mi nh SE
Hong Kong Excha nges
Indones i a SE
Ja pa n Excha nge Group - Os a ka
Ja pa n Excha nge Group - Tokyo
Korea Excha nge
Na ti ona l Stock Excha nge Indi a
New Zea l a nd Excha nge
Phi l i ppi ne SE
Sha ngha i SE
Shenzhen SE
Si nga pore Excha nge
Ta i wa n SE Corp.
The Stock Excha nge of Tha i l a nd
Total region
1 288 708.3
1 558 299.7
459 004.4
23 665.1
84 822.5
46 067.0
3 233 030.6
422 127.0
NA
4 377 994.4
1 212 759.5
1 520 925.1
74 415.7
261 840.7
3 932 527.7
2 072 420.0
752 831.0
850 943.1
430 426.6
21 081 883.2
-5.7%
36.8%
-8.3%
25.8%
8.7%
15.0%
4.3%
21.8%
-3.6%
-1.8%
36.7%
12.8%
20.5%
57.5%
42.7%
1.1%
3.4%
21.5%
13.8%
3.1%
39.6%
-2.1%
26.2%
15.3%
16.6%
4.3%
23.9%
9.9%
2.3%
39.5%
18.8%
21.4%
61.4%
46.3%
6.1%
9.7%
21.6%
113 740.0
3.7%
3.7%
Exchange
Europe - Africa - Middle East
Abu Dha bi SE
2014
% change /
Dec 13
(in local cur)
http://www.worldexchanges.org/statistics/
monthly-reports
Shanghai SE
Shenzhen SE
Singapore Exchange
Taiwan SE Corp.
The Stock Exchange of Thailand
Total region
3 932 527.7
2 072 420.0
752 831.0
850 943.1
430 426.6
21 081 883.2
57.5%
42.7%
1.1%
3.4%
21.5%
13.8%
61.4%
46.3%
6.1%
9.7%
21.6%
Europe - Africa - Middle East
Abu Dhabi SE
Amman SE
Athens Exchange
BME Spanish Exchanges
Borsa Istanbul
Budapest SE
Casablanca SE
Cyprus SE
Deutsche Börse
Dubai Financial Market
Egyptian Exchange
Euronext
Irish SE
Johannesburg SE
Kazakhstan SE
Ljubljana SE
Luxembourg SE
Malta SE
Mauritius SE
Moscow Exchange
Muscat Securities Market
NASDAQ OMX Nordic Exchange
Oslo Børs
Qatar Stock Exchange
Saudi Stock Exchange - Tadawul
SIX Swiss Exchange
Tel Aviv SE
Wiener Börse
Total region
113 740.0
25 554.9
55 154.3
992 913.6
219 762.6
14 513.3
52 746.8
4 031.0
1 738 539.1
87 858.9
70 083.7
3 319 062.2
143 465.8
933 930.7
22 973.4
7 519.4
63 167.5
3 641.7
8 751.0
385 926.7
37 830.5
1 196 725.4
219 369.7
185 860.3
483 115.5
1 495 314.2
200 525.0
96 790.3
12 178 867.4
3.7%
-0.8%
-33.2%
-11.1%
12.3%
-26.7%
-2.0%
91.5%
-10.2%
13.7%
-7.4%
-15.7%
-0.9%
-12.4%
5.5%
-19.7%
-2.1%
-49.9%
2.9%
-5.7%
-17.3%
21.8%
3.4%
-2.9%
-1.4%
-17.7%
-8.7%
3.7%
-0.8%
-24.0%
1.3%
22.2%
-11.3%
8.8%
118.1%
2.3%
17.0%
5.5%
-4.0%
9.4%
3.6%
20.1%
-8.5%
3.4%
-8.6%
2.9%
7.4%
2.2%
21.8%
3.4%
8.4%
10.6%
-6.3%
WFE Total
63 529 750.7
5.6%
http://www.worldexchanges.org/statistics/monthlyreports
Globalization of Stock Markets
 Barriers to international stock trading have decreased
 Reduction in information costs
 Reduction in exchange rate risk
 Correlation among markets (1987 crash)
 In 2007, NYSE merged with stock exchanges in Paris,
Brussels, and Amsterdam (called NYSE Euronext).
Merger with German stock exchange is on hold.
 ADRs
 Foreign co. desire to tap into US markets but SEC requirements
are costly, so many will sell ADRs (American Depository Receipts).
 See http://www.adrbnymellon.com/dr_directory.jsp (e.g. Honda,
ticker HMC)
Globalization of Stock Markets
 Methods used to invest in foreign shares
 Direct purchases (limited market)
 American Depository Receipts (ADRs)
 Advantages: Fin. Stmt. per US GAAP, lots of info by analysts, reliable
quotes
 Disadvantage: less liquid than US stocks
 International mutual funds
 World equity benchmark shares (WEBs or international iShares)