Chpt019(1).ppt

,Corporate Finance Ross Westerfield Jaffe,Sixth Edition,Executive Summary,This chapter looks at how corporations issue securities to the investing public.The basic procedure for selling debt and equity securities are essentially the same.This chapter focuses on equity.,Chapter Outline,19.1 The Public Issue19.2 Alternative Issue Methods19.3 The Cash Offer19.4 The Announcement of New Equity and the Value of the Firm19.5 The Cost of New Issues19.6 Rights19.7 The Rights Puzzle19.8 Shelf Registration19.9 The Private Equity Market19.10 Summary and Conclusions,19.1 The Public Issue,The Basic ProcedureManagement gets the approval of the Board of Directors.The firm prepares and files a registration statement with the SEC.The SEC studies the registration statement during the waiting period.The firm prepares and files an amended registration statement with the SEC.If everything is copasetic with the SEC,a price is set and a full-fledged selling effort gets underway.,The Process of A Public Offering,Steps in Public OfferingTime1.Pre-underwriting conferences2.Registration statements 3.Pricing the issue4.Public offering and sale 5.Market stabilization,Several months 20-day waiting period Usually on the 20th day After the 20th day 30 days after offering,An Example of a Tombstone Advertisement,19.2 Alternative Issue Methods,There are two kinds of public issues:The general cash offerThe rights offerAlmost all debt is sold in general cash offerings.,19.3 The Cash Offer,There are two methods for issuing securities for cash:Firm CommitmentBest EffortsThere are two methods for selecting an underwriterCompetitiveNegotiated,Firm Commitment,Under a firm commitment underwriting,the investment bank buys the securities outright from the issuing firm.Obviously,they need to make a profit,so they buy at“wholesale”and try to resell at“retail”.To minimize their risk,the investment bankers combine to form an underwriting syndicate to share the risk and help sell the issue to the public.,Best Efforts,Under a best efforts underwriting,the underwriter does not buy the issue from the issuing firm.Instead,the underwriter acts as an agent,receiving a commission for each share sold,and using its“best efforts”to sell the entire issue.This is more common for initial public offerings than for seasoned new issues.,19.4 The Announcement of New Equity and the Value of the Firm,The market value of existing equity drops on the announcement of a new issue of common stock.Reasons includeManagerial InformationSince the managers are the insiders,perhaps they are selling new stock because they think it is overpriced.Debt CapacityIf the market infers that the managers are issuing new equity to reduce their debt-equity ratio due to the specter of financial distress the stock price will fall.Falling Earnings,19.5 The Cost of New Issues,Spread or underwriting discountOther direct expensesIndirect expensesAbnormal returnsUnderpricingGreen Shoe Option,The Costs of Public Offerings,EquityProceeds Direct CostsUnderpricing(in millions)SEOsIPOsIPOs 2-9.9913.28%16.96%16.36%10-19.998.72%11.63%9.65%20-39.996.93%9.70%12.48%40-59.995.87%8.72%13.65%60-79.995.18%8.20%11.31%80-99.994.73%7.91%8.91%100-199.994.22%7.06%7.16%200-499.993.47%6.53%5.70%500 and up3.15%5.72%7.53%,19.6 Rights,If a preemptive right is contained in the firms articles of incorporation,the firm must offer any new issue of common stock first to existing shareholders.This allows shareholders to maintain their percentage ownership if they so desire.,Mechanics of Rights Offerings,The management of the firm must decide:The exercise price(the price existing shareholders must pay for new shares).How many rights will be required to purchase one new share of stock.These rights have value:Shareholders can either exercise their rights or sell their rights.,Rights Offering Example,Popular Delusions,Inc.is proposing a rights offering.There are 200,000 shares outstanding trading at$25 each.There will be 10,000 new shares issued at a$20 subscription price.What is the new market value of the firm?What is the ex-rights price?What is the value of a right?,Rights Offering Example,What is the new market value of the firm?There are 200,000 outstanding shares at$25 each.There will be 10,000 new shares issued at a$20 subscription price.,Rights Offering Example,What is the ex-rights price?There are 110,000 outstanding shares of a firm with a market value of$5,200,000.Thus the value of an ex-rights share is:,Thus the value of a right is$0.2381=$25$24.7619,19.7 The Rights Puzzle,Over 90%of new issues are underwritten,even though rights offerings are much cheaper.A few explanations:Underwriters increase the stock price.There is not much evidence for this,but it sounds good.The underwriter provides a form of insurance to the issuing firm in a firm-commitment underwriting.The proceeds from underwriting may be available sooner than the proceeds from a rights offering.No one explanation is entirely convincing.,19.8 Shelf Registration,Permits a corporation to register an offering that it reasonably expects to sell within the next two years.Not all companies are allowed shelf registration.Qualifications include:The firm must be rated investment grade.The cannot have recently defaulted on debt.The market capitalization must be$75 m.No recent SEC violations.,19.9 The Private Equity Market,The previous sections of this chapter assumed that a company is big enough,successful enough,and old enough to raise capital in the public equity market.For start-up firms and firms in financial trouble,the public equity market is often not available.,Private Placements,Avoid the costly procedures associated with the registration requirements that are a part of public issues.The SEC restricts private placement issues ot no more than a couple of dozen knowledgeable investors including institutions such as insurance companies and pension funds.The biggest drawback is that the securities cannot be easily resold.,Venture Capital,The limited partnership is the dominant form of intermediation in this market.There are four types of suppliers of venture capital:Old-line wealthy families.Private partnerships and corporations.Large industrial or financial corporations have established venture-capital subsidiaries.Individuals,typically with incomes in excess of$100,000 and newt worth over$1,000,000.Often these“angels”have substantial business experience and are able to tolerate high risks.,Stages of Financing,Seed-Money Stage:Small amount of money to prove a concept or develop a product.Start-UpFunds are likely to pay for marketing and product refinement.First-Round FinancingAdditional money to begin sales and manufacturing.Second-Round FinancingFunds earmarked for working capital for a firm that is currently selling its product but still losing money.Third-Round FinancingFinancing for a firm that is at least breaking even and contemplating expansion;a.k.a.mezzanine financing.Fourth-Round FinancingFinancing for a firm that is likely to go public within 6 months;a.k.a.bridge financing.,19.10 Summary and Conclusions,Larger issues have proportionately much lower costs of issuing equity than small ones.Firm-commitment underwriting is far more prevalent for large issues than is best-effort underwriting.Smaller issues probably use best effort because of the greater uncertainty.Rights offering are cheaper than general cash offers.Shelf registration is a new method of issuing new debt and equity.Venture capitalists are an increasingly important influence in start-up firms and subsequent financing.,