Prof. Ian Giddy New York University Global Equity Financing

Copyright ©2002 Ian H. Giddy Global Equity 2 Corporate Finance CORPORATE FINANCE DECISONS CORPORATE FINANCE DECISONS INVESTMENT RISK MGT FINANCING CAPITAL PORTFOLIO M&A DEBTEQUITY TOOLS MEASUREMENT

Copyright ©2002 Ian H. Giddy Global Equity 3 Corporate Finance CORPORATE FINANCE DECISONS CORPORATE FINANCE DECISONS INVESTMENT RISK MGT FINANCING CAPITAL PORTFOLIO M&A DEBTEQUITY TOOLS MEASUREMENT

Copyright ©2002 Ian H. Giddy Global Equity 4 Corporate Finance CORPORATE FINANCE DECISONS CORPORATE FINANCE DECISONS INVESTMENT RISK MGT FINANCING CAPITAL PORTFOLIO M&A DEBTEQUITY TOOLS MEASUREMENT INVESTMENT FINANCING RISK MANAGEMENT

Copyright ©2002 Ian H. Giddy Global Equity 5 Primary Market for Equities Initial Public Offering (IPO) Subsequent Offering Private Equity Placement Stock Buyback? Management Buyout?

Copyright ©2002 Ian H. Giddy Global Equity 6 EquityBankingFixed Income Investment Banking: Organizarion “Coverage” Corporate Finance Mergers & Acquisitions Investment Banking Debt Capital Markets (DCM) Syndicate Marketing Sales Institutional Retail Trading (proprietary) Risk Profits Structured Finance Credit Research Private Placement Loan Syndication Equity Capital Markets (ECM) Sales Trading Research

Copyright ©2002 Ian H. Giddy Global Equity 7 Investment Banking: Organization New Deal Pitch Team l Coverage/ Investment banking l Product (DCM or ECM) Commitment Committee l Investment banking l ECM/DCM l Senior sales/trading l Research

Copyright ©2002 Ian H. Giddy Global Equity 8 Underwriting Sequence l Engagement: Mandate signed by issuer engaging lead manager l Due Diligence: Conducted by Lead manager l Documentation: Loan agreement, Prospectus l Signing: Underwriting agreement signed and issue priced l Closing: Settlement of the offering Engagement Due Diligence and Documentation Due Diligence and Documentation Signing and Pricing Closing

Copyright ©2002 Ian H. Giddy Global Equity 9 The Beauty Contest Criteria for Selecting a Lead Manager 1 l Experience with similar transactions (sector, market, currency, maturity, high or low-quality issuers) l Ranking in League Tables l Placement power with institutional and/or retail investors l Standing in secondary market as “market maker” and commitment to secondary market trading

Copyright ©2002 Ian H. Giddy Global Equity 10 The Beauty Contest (Cont.) Criteria for Selecting a Lead Manager 2 l Quality/reputation of research l Proposed marketing strategy (pricing, timing, issue size, etc.) l Proposals for “Roadshow” l Relationships with potential co- managers l Senior management commitment to backing issue with people and capital

Copyright ©2002 Ian H. Giddy Global Equity 11 The Roadshow l Organized by global coordinator and lead managers l Informal presentation by management to potential investors l Attendance limited to professional intermediaries and investing institutions l Content must be consistent with information in draft version of prospectus or offering circular.

Copyright ©2002 Ian H. Giddy Global Equity 12 Syndication: The Structure Lead Manager Book-Runner “International Coordinator Joint Co-Lead Manager Joint Co-Lead Manager Joint Co-Lead Managers Lead Manager Lead Manager Lead Managers Manager ManagersSelling Agent Co-Lead Manager

Copyright ©2002 Ian H. Giddy Global Equity 13 Securities Underwriting: Relationships Issuer AgentsInvestment Bankers Debt: Fiscal agent Equity: Depositary institution Lead manager/Bookrunner Registered offering: Underwriting Agreement Unregistered: Purchase Agreement Co-managers Agreement Among Underwriters Prospectus/Offering Circular Institutional BuyersRetail Buyers

Copyright ©2002 Ian H. Giddy Global Equity 14 Subscription or Underwriting Agreement l Between issuer, global coordinator and all managers l Signed after pricing when “book-building” completed l Firm commitment to underwrite, subject to delivery of certain confirmatory certificates and no “material adverse change” or “force majeure” l Indemnity: By the issuer in favor of Global Coordinator and Managers against liability arising as a breach of warranty, material inaccuracy or omission l Lock up: Issuer will not offer other securities for a period of time (eg six months)

Copyright ©2002 Ian H. Giddy Global Equity 15 Debt Equity Domestic market Foreign market (Depositary Receipts) BNY ADR Index -7.47% % % MSCI Index % % % Asia Lat Amer Emerging Markets ( ) What Form of Issue?

Copyright ©2002 Ian H. Giddy Global Equity 16 ADR (American Depository Receipts) INVESTORS LOCAL DEPOSITARY INSTITUTION U.S. BANK U.S. investor buys certificate which represents a foreign market security. It receives the same treatment as a U.S. security and trades freely in the U.S. Holds shares of non-U.S. issuer on behalf of investors NON-U.S. ISSUER Non-U.S. issuer gains better access to U.S. market and may provide superior disclosure

Copyright ©2002 Ian H. Giddy Global Equity 17 Debt Equity Domestic market Foreign market (Depositary Receipts) UnsponsoredPrivate placement Exchange traded Exchange traded IPO Private placement IPO Global issue or GDR Depositary Receipts: Alternatives

Copyright ©2002 Ian H. Giddy Global Equity 18 Equity-Linked Eurobonds l Eurobonds with warrants  Marui l Convertible Eurobonds  Battle Mountaingold l Index-linked Eurobonds  Bank of Montreal

Copyright ©2002 Ian H. Giddy Global Equity 19 Equity Financing Choices Equity Warrants Conver- tibles ADRsCommon

Copyright ©2002 Ian H. Giddy Global Equity 20 Pricing Debt Instruments l Bonds priced according to yield over benchmark (spread) l Yield too low – issue does not sell l Yield too high – too much given away l Generally syndicate holds price for a day; in a successful issue yields gradually tighten Equity l Mature issue: based on current market price and market conditions, small premium for dilution; comparables l IPO: comparables and discounted cash flow analysis

Copyright ©2002 Ian H. Giddy Global Equity 21 Pricing and Fees The Business n Telecoms n Dot-Coms n Avons (How much volatility?) Debt Equity Fees 0.15% to 1.5% 5% to 7% Pricing T+Spread L+Spread Comparables/Ratios The market Future cash flow valuation The Issuer

Copyright ©2002 Ian H. Giddy Global Equity 22 Relative Valuation l Do valuation ratios make sense? Price/Earnings (P/E) ratios q and variants (EBIT multiples, EBITDA multiples, Cash Flow multiples) Price/Book (P/BV) ratios q and variants (Tobin's Q) Price/Sales ratios l It depends on how they are used -- and what’s behind them!

Copyright ©2002 Ian H. Giddy Global Equity 23 Valuing a Firm with DCF: An Illustration Historical financial results Adjust for nonrecurring aspects Gauge future growth Adjust for noncash items Projected sales and operating profits Projected free cash flows to the firm (FCFF) Year 1 FCFF Year 2 FCFF Year 3 FCFF Year 4 FCFF Terminal year FCFF Stable growth model or P/E comparable Present value of free cash flows + cash, securities & excess assets - Market value of debt Value of shareholders equity … Discount to present using weighted average cost of capital (WACC)

Copyright ©2002 Ian H. Giddy Global Equity 24 Dividend Discount Models: General Model l V 0 = Value of Stock l D t = Dividend l k = required return

Copyright ©2002 Ian H. Giddy Global Equity 25 Constant Growth Model l g = constant perpetual growth rate

Copyright ©2002 Ian H. Giddy Global Equity 26 Constant Growth Model: Example E 1 = $5.00b = 40% k = 15% (1-b) = 60%D 1 = $3.00 g = 8% V 0 = 3.00 / ( ) = $42.86 n Motel 6 has earnings of $5 per share. It reinvests 40% and pays out 60%dividend n The required return that shareholders expect is 15% n The earnings are expected to grow at 8% per annum n What’s an M6 share worth? n Motel 6 has earnings of $5 per share. It reinvests 40% and pays out 60%dividend n The required return that shareholders expect is 15% n The earnings are expected to grow at 8% per annum n What’s an M6 share worth? Plowback rate

Copyright ©2002 Ian H. Giddy Global Equity 27 Shifting Growth Rate Model l g 1 = first growth rate l g 2 = second growth rate l T = number of periods of growth at g 1

Copyright ©2002 Ian H. Giddy Global Equity 28 The Investors’ Viewpoint: Equity Risk and Return l Investors diversify, because you get a better return for a given risk. l There is a fully-diversified “market portfolio” that we should all choose l The risk of an individual asset can be measured by how much risk it adds to the “market portfolio.” But does this apply to the global capital market?

Copyright ©2002 Ian H. Giddy Global Equity 29 The Weighted Average Cost of Capital ChoiceCost 1. EquityCost of equity - Retained earnings- depends upon riskiness of the stock - New stock issues- will be affected by level of interest rates - Warrants Cost of equity = riskless rate + beta * risk premium 2. DebtCost of debt - Bank borrowing- depends upon default risk of the firm - Bond issues- will be affected by level of interest rates - provides a tax advantage because interest is tax-deductible Cost of debt = Borrowing rate (1 - tax rate) Debt + equity = Cost of capital = Weighted average of cost of equity and Capitalcost of debt; weights based upon market value. Cost of capital = k d [D/(D+E)] + k e [E/(D+E)]

Copyright ©2002 Ian H. Giddy Global Equity 30 International Equity Markets and Portfolio Diversification l No well-accepted international version of the capital asset pricing model. l The benefits of diversification globally are empirical issues. l The empirical case for international diversification has two components.  Establish the riskiness of foreign investment, and the extent to which combining a foreign with a domestic portfolio reduces risk.  Even if it reduces risk, does foreign investment also reduce expected return? l Then what we have to do is make sure we understand how international diversification is best achieved.

Copyright ©2002 Ian H. Giddy Global Equity 31 International Diversification Pays More P o r t f o l i o R i s k  kp Number of Securities (Assets) in Portfolio TOTAL RISK NONDIVERSIFIABLE RISK DIVERSIFIABLE RISK

Copyright ©2002 Ian H. Giddy Global Equity 32 The Global Efficient Frontier

Prof. Ian Giddy New York University Raising and Pricing Equity

Copyright ©2002 Ian H. Giddy Global Equity 34 Raising Equity: The Investment Banker’s Job l Market conditions l Corporate needs l Valuation l Information l Distribution Teleko m

Copyright ©2002 Ian H. Giddy Global Equity 35 Deutsche Telekom: The Sequence l See case Exhibit 2

Copyright ©2002 Ian H. Giddy Global Equity 36 What’s a Company Worth to Investors? l Required Returns l Types of Models  Balance sheet models  Dividend discount & corporate cash flow models  Price/Earnings ratios  Option models l Estimating Growth Rates Teleko m

Copyright ©2002 Ian H. Giddy Global Equity 37 Equity Valuation: From the Balance Sheet Value of Assets n Book n Liquidation n Replacement Value of Liabilities n Book n Market Value of Equity

Copyright ©2002 Ian H. Giddy Global Equity 38 Deutsche Telekom: Book Value l See case Exhibit 3

Copyright ©2002 Ian H. Giddy Global Equity 39 Relative Valuation l Do valuation ratios make sense? Price/Earnings (P/E) ratios q and variants (EBIT multiples, EBITDA multiples, Cash Flow multiples) Price/Book (P/BV) ratios q and variants (Tobin's Q) Price/Sales ratios l It depends on how they are used -- and what’s behind them!

Copyright ©2002 Ian H. Giddy Global Equity 40 Deutsche Telekom: Ratios and Comparables l See case page 9

Copyright ©2002 Ian H. Giddy Global Equity 41 Discounted Cashflow Valuation: Basis for Approach  where  n = Life of the asset  CF t = Cashflow in period t  r = Discount rate reflecting the riskiness of the estimated cashflows

Copyright ©2002 Ian H. Giddy Global Equity 42 Deutsche Telekom: Earnings l See case page 8

Copyright ©2002 Ian H. Giddy Global Equity 43 Valuing a Firm with DCF: An Illustration Historical financial results Adjust for nonrecurring aspects Gauge future growth Adjust for noncash items Projected sales and operating profits Projected free cash flows to the firm (FCFF) Year 1 FCFF Year 2 FCFF Year 3 FCFF Year 4 FCFF Terminal year FCFF Stable growth model or P/E comparable Present value of free cash flows + cash, securities & excess assets - Market value of debt Value of shareholders equity … Discount to present using weighted average cost of capital (WACC)

Copyright ©2002 Ian H. Giddy Global Equity 44 What’s a Company Worth? Alternative Models l The options approach  Option to expand  Option to abandon l Creation of key resources that another company would pay for  Patents or trademarks  Teams of employees  Customers l Examples? Lycos Messageclick.co m

Copyright ©2002 Ian H. Giddy Global Equity 45 Raising Equity: The Investment Banker’s Job l Market conditions l Corporate needs l Valuation l Information l Distribution Teleko m T- Online

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Copyright ©2002 Ian H. Giddy Global Equity 50 Contact Ian H. Giddy NYU Stern School of Business 44 West 4th Street, New York, NY 10024, USA Tel