Transcript Equity Issues

How corporations
issue securities
God Himself could not sink this ship”– Titanic deckhand April 10, 1912
Venture Capital
Venture Capital
Money invested to finance a new firm
Since success of a new firm is highly dependent
on the effort of the managers, restrictions are
placed on management by the venture capital
company and funds are usually dispersed in
stages, after a certain level of success is achieved.
U.S.120 Venture Capital Investments
104.4
80
53.5
60
40.5
2005
22.4
19.6 21.8
2004
21.7
2003
2001
2000
1999
1998
14.6
1997
0
7.9
10.8
1996
20
20.7
2002
40
1995
$ Millions
100
Venture Capital:
Performance
• SIGNALING
Words are cheap but you are more likely to trust an entrepreneur who
puts his money where his mouth is.
• Venture Capital Performance [Huntsman and Hoban (1980), Barry
( 1994)]
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
Percent of CFOs who strongly agree with the reason for an
IPO
To create public shares for use in future acquisitions
59.4
To establish a market price/value for our firm
51.2
To enhance the reputation of our company
49.1
To broaden the base of ownership
45.9
To allow one or more principals to diversify personal holdings
44.1
To minimize our cost of capital
42.5
To allow venture capitalists to cash out
32.2
To attract analysts' attention
29.8
Our company has run out of private equity
27.6
Debt is becoming too expensive
14.3
0
10
20
30
40
50
60
70
Return from Investing in
Initial Public Offerings (IPOs)
• Deliberate underpricing?
• Large Initial Returns of 16.4% during first day.
[Ibbotson, Sindelar and Ritter (1988)
– Who gets this? [Barry and Jennings (1993)
• What is the long Run Performance? [Levis(1993)]
New Equity Issues Winners' Curse
(or why issues may be underpriced)
•
Underpriced issues are generally oversubscribed & overpriced issues are
undersubscribed.
•
Investors who apply for every issue, will tend to receive a small allocation of
underpriced issues & a large allocation of overpriced issues.
•
If issues are on average fairly priced, then uninformed investors will not
apply for new issues.
•
Therefore a discount may be needed to attract uninformed investors.
IPOs (Unseasoned Issues) in U.S.
A couple of examples..
April 1996 Optical Cable Corp. was sold at $10 a share. After 1
month price hit a high of $136 before falling to $57 three days
later.
July 1995 underwriters indicated that Netscape would sell 3.5
million shares at $12 - $14 each. A few days later they increased
shares available to 5 million and upped price range to $21 - $24.
That evening they set the final price at $28. Next morning
trading opened 1 1/2 hours late at a price of $71, valuing the
firm at $2 billion.
Costs of Microsoft IPO
Combined primary and secondary issue.
Underwriters acquired 2.8m shares at $19.69 and resold them at $21
Legal and other costs = $.5m
Initial market price = $35
Direct expenses:
Spread
Other expenses
Total direct expenses
Proceeds
Expenses as % of proceeds
2.8m x $1.31 = $3.7m
.5
$4.2m
2.8m x $19.69 = $54.6m
4.2/54.6 = 7.1%
Cost of underpricing
2.8m x ($35 - $21) = $39.2m
Total expenses
$43.4m
Market value of issue
2.8m x $35 = $98 m
Expenses as % of market value
43.4/98 = 44%
Average expenses of going public (USA)
Value of
Issue ($m)
Direct
costs %
Average initial
return %
2 - 10
10 - 20
20 - 40
40 - 60
60 - 80
80 - 100
100 - 200
200 - 500
> 500
All issues
17.0
11.6
9.7
8.7
8.2
7.9
7.1
6.5
5.7
11.0
16.4
9.7
12.5
13.7
11.3
8.9
7.2
5.7
7.5
12.1
Total
costs %
25.2
18.2
18.2
18.0
16.4
14.1
12.8
11.1
10.4
18.7
Note: Direct costs and initial return are % of issue price. Total costs are
% of market price
Source: Ritter (1996)
IPO Proceeds
• IPO Proceeds and First Day Returns
80
70
60
50
40
Issue proceeds ($bn)
First-day return
30
20
10
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
0
Average Initial IPO Returns
Denmark
Canada
Netherlands
Spain
Turkey
France
Australia
Norway
Hong Kong
UK
USA
Italy
Japan
Singapore
Sweden
Taiwan
Germany
Switzerland
Korea
Brazil
India
China
256 %
0
20
40
60
return (percent)
80
100
U.S. direct issue costs 1990-1994
Costs %
20
15
10
5
0
IPOs
Second eqs
Convs
Bonds
2 to 10
20 to 40
60 to 80
100 to 200
Proceeds $m
500 +
Price Falls For Seasoned Issues
Type of security*
Avg. 2-day abnormal return (%)
Industrials
Utilities
Equity
-3.1
-0.8
Convertible bonds
-2.0
na
Convertible pref.
-1.4
-1.4
Preferred
-0.8
0.1
Straight bonds
-0.3
-0.1
*Firm commitment offers
Source: US evidence summarized in Eckbo & Masulis (1993)
Why stock issues cause a fall in the share price:
a possible explanation (Myers & Majluf)
•
Managers have better information than investors
•
Suppose managers believe stock is overpriced (It may be a good
time to sell)
•
•
If stock is overpriced, old shareholders get good deal.
Investors know managers are more likely to issue stock
when it is overvalued and therefore mark down the price