SOURCING EQUITY GLOBALLY Multinational Business Finance (2nd Edition) Chapter 14 David Eiteman | Kevin Daly Subhrendu Rath | Arthur Stonehill | Michael Moffett SOURCING EQUITY GLOBALLY

Sourcing Equity Globally Focus Companies resident in less liquid or segmented Markets need to tap liquid and unsegmented markets in order to attain the global cost and availability of capital. These companies are typically resident in emerging-market countries and many of the smaller industrial country markets. Even though they source equity and debt overseas, it is unlikely to have as favourable an impact on their cost and availability of capital To implement the goal of gaining access to global capital markets a firm must begin by designing a strategy that will ultimately attract international investors.

Sourcing Equity Globally Designing a strategy to source equity globally Designing a capital sourcing strategy requires management to agree upon a long-run financial objective and to choose between the various alternative paths to get there (See Figure 14.1for the ultimate objective of attaining a global cost and availability of capital)

Sourcing Equity Globally Designing a strategy to source equity globally (Page 410)

Sourcing Equity Globally The choice of paths and implementation is aided by an early appointment of an investment bank as official Investment bankers are in touch with the potential foreign investors and what they are currently requiring. can help navigate the various institutional requirements and barriers that must be satisfied. provide services which include advising if, when and where a cross-listing should be initiated. help to prepare the required stock prospectus if an equity issue is desired and to price the issue and Maintain an aftermarket to prevent the share price from falling below its initial price.

Designing a Strategy to Source Equity Globally Depositary receipts Negotiable certificates issued by a bank to represent the underlying shares of stock, which are held in trust at a foreign custodian bank. American depository receipts (ADRs) ADRs are traded only in the United States and denominated in US dollars Global Registered Shares (GRSs) GRSs can be traded on equity exchanges around the globe in a variety of currencies

Designing a Strategy to Source Equity Globally American depository receipts (ADRs) (Page 411)

Designing a Strategy to Source Equity Globally American depository receipts (ADRs) ADRs are used in the US in the same manner as any share of stock with each ADR representing some multiple of the underlying foreign share ADRs can be exchanged for the underlying foreign shares

Designing a Strategy to Source Equity Globally American depository receipts (ADRs) ADRs also convey certain technical advantages to US shareholders. Subject to US legal environment Quoted only in US dollars Traded only in the US Pay dividend in US dollar Lower trading cost Faster settlement .

Designing a Strategy to Source Equity Globally American depository receipts (ADRs) Sponsored ADRs are created at the request of a foreign company wanting its shares traded in the United States Unsponsored ADRs are created by a US securities company If a foreign company does not seek to have its shares traded in the United States but US investors are interested

Foreign Equity Listing and Issuance A firm must choose one or more stock markets on which to cross-list its shares and sell new equity. Just where to go depends mainly on the firm’s specific motives and the willingness of the host stock market to accept the firm.

Foreign Equity Listing and Issuance Objectives of cross-listing: Improve the liquidity of its existing shares and support a liquid secondary market for new equity issues in foreign markets Increase its share price by overcoming mispricing in a segmented and illiquid home capital market Increase the firms visibility Establish a secondary market for shares used to acquire other firms Create a secondary market for shares that can be used to compensate local management and employees in foreign subsidiaries

Foreign Equity Listing and Issuance Global registered shares (GRSs) Similar to ordinary shares GRSs have the added benefit of being able to be traded on equity exchanges around the globe in a variety of currencies GRS are traded electronically First used for cross-border trading of Canadian company securities in the United States

Effect of Cross-Listing and Equity Issuance on Share Price Benefits of cross-listing depend on the degree to which markets are segmented Impact of ADR program on the issuing company [Frino, Di Marco and Lepone (2009)] The reduction of proportional bid-ask spread for active ADR companies is more than double that of comparative control stocks. Similarly, the increase in turnover for active ADR companies is more than double that of comparative control stocks. OTC-traded ADRs have a more significant effect on the overall change in liquidity than exchange-traded stocks. The time interval between listing and trading may be delaying the potential benefits of issuing an ADR.

Effect of Cross-Listing and Equity Issuance on Share Price Benefits Increased investors recognition Enlarge shareholder base Increase participation in both the primary and secondary markets The marketing efforts by the underwriters prior to the issue engender higher level of visibility Reduce investors risk

Effect of Cross-Listing and Equity Issuance on Share Price Benefits Increasing visibility and political acceptance Increasing potential for share swaps with acquisitions Compensating management and employees

Barriers to Cross-Listing and Selling Equity Abroad A decision to cross-list must be balanced against the implied increased commitment to full disclosure and a continuing investor relations program Two different thoughts The worldwide trend towards requiring fuller, more transparent and more standardised financial disclosure of operating results and financial positions may have the desirable effect of lowering the cost of equity capital. The US level of required disclosure is an onerous, costly burden

Alternative Instruments to Source Equity in Global Markets Alternative instruments to source equity in global markets include the following: Sale of a directed public share issue to investors in a target market Sale of a Euroequity public issue to investors in more than one market (foreign and domestic markets) Sale of shares to private equity funds Sale of shares to a foreign firm as part of a strategic alliance

Alternative Instruments to Source Equity in Global Markets A directed public share issue is targeted at investors in a single country and underwritten in whole or in part by investment institutions from that country. The issue might or might not be denominated in the currency of the target market. The shares might or might not be cross-listed on a stock exchange in the target market.

Alternative Instruments to Source Equity in Global Markets Euroequity public issue A company can issue equity underwritten and distributed in multiple foreign equity markets, sometimes simultaneously with distribution in the domestic market. The “Euro” market (a generic term for international securities issues originating and being sold anywhere in the world) was created by the same financial institutions that had previously created an infrastructure for the Euronote and Eurobond markets.

Alternative Instruments to Source Equity in Global Markets Private equity funds Limited partnerships of institutional and wealthy individual investors that raise their capital in the most liquid capital markets. These investors then invest the private equity fund in mature, family-owned firms located in emerging markets. The investment objective is to help these firms to restructure and modernise in order to face increasing competition and the growth of new technologies. Private equity funds differ from traditional venture capital funds as private equity funds operate in many countries, fund companies in many industry sectors and have often have a longer time horizon for exiting.

Alternative Instruments to Source Equity in Global Markets Strategic alliances are normally formed by firms that expect to gain synergies from one or more of the following joint efforts: Sharing the cost of developing technology Gaining economies of scale or scope Financial assistance (lowering of cost of capital through attractively priced debt or equity financing)

Mini-Case Questions:Petrobrás of Brazil and the cost of capital Why do you think Petrobrás’s cost of capital is so high? Are there better ways, or other ways, of calculating its weighted average cost of capital? Does this method of using the sovereign spread also compensate for currency risk? The final quote that ‘one’s view on the direction of the broad Brazilian market’ suggests that potential investors consider the relative attractiveness of Brazil in their investment decision. How does this perception show up in the calculation of the company’s cost of capital? Is the cost of capital really a relevant factor in the competitiveness and strategy of a company like Petrobrás? Does the corporate cost of capital really affect competitiveness?

Additional Exhibits (Page 411)

(Page 420)