1. Investment Banking Public and Private Placement
Chapter 15
McGraw-Hill/Irwin
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Chapter Outline Who are investment bankers
Costs and risk involved in distribution of new securities
Distribution of new securities and dilution of earnings per share
Public versus private financing
Leveraged buyouts and restructuring of a corporation

3. The Role of Investment Banking
The investment banker is the link between the corporations in need of funds and the investor
Investment bankers are responsible for designing and packaging a security, offering and selling the securities to the public

4. Concentration of Capital
Allows large firms to take additional risks and satisfy the needs of an increasingly demanding capital market
Raising capital has become an international proposition
International consolidations and buy-outs of banks have become common

5. Investment Banking Competitors
Intense competition in the market and there are various dimensions of competition such as fees, pricing accuracy, analyst recommendations and debt offering abilities.
Being a leader in one sector helps a firm’s overall reputation but does not ensure success in all areas.

6. Functions of Investment Bankers
As a middleman in the distribution of securities, the investment banker has a key role of:
Underwriter
Market maker
Client advisor
Agency services to corporations

7. Underwriter
Contracting to buy securities from a corporation and re-selling them to security dealers and the public
Underwriting
Giving a “firm commitment” to purchase securities from the corporation
Assuming any risks associated with the new issue
Best-efforts
Undertaking to do the very best in selling a security issue to the public, on commission basis, without committing any quantity

8. Market Maker
Buying and selling of securities issued to ensure a liquid market
Providing research on the firm to encourage active investor interest

9. Advisor Advising clients on a continuing basis about:
Types of securities to be sold
Number of shares or units to be distributed
Timing of such sale
Offering other advisory services in the areas of M&A, leveraged buyouts, and corporate restructuring

10. Agency Functions
Acting as an agent to a corporation to place its securities privately with:
An insurance company
A pension fund
A wealthy individual
Negotiating for a best possible deal with the potential investors

11. The Distribution Process in Investment Banking

12. The Distribution Process in Investment Banking (cont’d)
Principal investment banker calls on other investment houses to share burden of risk and aid in distribution
Underwriting syndicate is formed comprising many investment houses
Syndicate members act as wholesalers in distributing the shares to brokers and dealers
Brokers and dealers sell the shares to the public

13. Underwriting Spread
Represents the total compensation for all participants in the distribution process

14. The Underwriting Spread(con’d)
The lower a party falls in the distribution process, the higher is the price for shares
The farther down the line the securities are resold, the higher is the potential profit
The larger the dollar value of an issue, the smaller the spread is as a percentage of the offering price

15. Pricing the Security
The managing investment banker determines the price by conducting an in-depth analysis on the following:
Company’s industry
Financial characteristics
Anticipated earnings
Dividend-paying capability

16. Pricing the Security (cont’d)
Based on a technique deemed appropriate by the underwriter:
A tentative price is assigned
Price is compared to industry peers
Anticipated public demand also plays a major factor
Underpricing
Setting the price slightly below the current market value
Common during the issuance of additional shares

17. Dilution Issuance of additional securities result in:
Actual or perceived dilution of earnings for shares currently outstanding
Current profit distributable to more number of outstanding shares
A perceived time lag in the recovery of earning per share
Resulting from increase in shares outstanding
Temporary weakness in price
The proceeds from additional issue may be expected to provide additional earnings

18. Market Stabilization
An investment banker stabilizes the offering during distribution period by:
Repurchasing securities when market price goes below the initial public offering price
Period of stabilization lasts for two or three days after initial offering, but may extend up to 30 days
Stabilization may be virtually impossible in case of poor market environment
Price manipulation in security markets is illegal
An exception to this is underwriter price support

19. Aftermarket
Research shows IPOs generally perform well in immediate aftermarket
Over the first three years of trading, IPO returns (excluding the first-day price jump), are approximately 6.5% lower than returns for similar sized firms
The IPO is a good deal for investors who purchase shares from the underwriter at the offering price
After the first day of trading most companies underperform the market for several years

20. Shelf Registration
Large firms filing one comprehensive registration statement:
Outlines the firm’s financing plans for up to two years
Allowed to issue securities without further SEC approval when market conditions are appropriate
Mostly use with debt issues, and utilize minimally with equity markets

21. Public versus Private Financing
Many companies prefer to remain private
Restricting their financial activities to direct dealings and negotiations with bankers, insurance companies etc.

22. Advantages of Being Public
To corporations:
Corporations can have access to greater amounts of funds
A public traded security helps in bank negotiations
A company can use its own stock as currency for the purchase of another firm
A company can issue marketable securities for the purchase of another firm

23. Advantages of Being Public (cont’d)
To stockholders:
Ability to achieve a higher degree of liquidity
Ability to diversify his/her portfolio
Holding a publicly traded stock helps in estate planning

24. Disadvantages of Being Public
Important corporate information on profit margins and product lines will be divulged through SEC and state filings
These filings are tedious, time-consuming, and expensive
Tremendous pressure from security analysts and large institutional Investors for short-term performance
Shift in management interest for short term performance against long-term stewardship
Relatively high cost for smaller firms going public
Underwriting spread and out-of-pocket costs can run in the 15% - 18% range

25. Public Offerings The act of issuing shares to the public
The issuing company has to file a registration statement with the SEC
Statement includes prospectus containing details about the company offering

26. Public Offerings – Classic Example
A classic example of recent IPO – Rosetta Stone
Refer to the chapter for the complete story [Pages ]

27. Public Offerings – Example (cont’d)

28. 2009 Stock Returns For Rosetta Stone and S&P 500 Index

29. Private Placement
Selling of securities not through the security market but directly to:
Insurance companies
Pension funds
Wealthy individuals
Such device employed to:
Avoid or defer an IPO offering
Incorporate private funds into the financing package
More than 50% of long-term corporate debt outstanding is privately placed

30. Advantages and Disadvantages of Private Placement
No lengthy, expensive registration process with the SEC
Greater flexibility in negotiating than is possible in a public offering
Lower initial costs in a private placement than those of a public issue
Disadvantage:
Interest rate on bonds is usually higher to compensate the investor for holding a less liquid obligation

31. Going Private and Leveraged Buy-outs
The trend:
1970s, a number of small firms gave up their public listings to be private
1980s, 1990s, and mid-2000s, very large companies began to go private
Reason:
Significant cost savings in annual report expenses, legal and auditing fees, and security analysts meetings

32. Going Private Absence of a public float Two methods of going private:
A publicly owned company purchased by a private company or a private equity fund
Repurchasing all publicly traded shares from stockholders
Leveraged buyout an easy way to go private

33. Leveraged Buyout
The management or some investor group borrows the needed cash to repurchase all shares of the company
The company exists with substantial debt and heavy interest cost
Management of the private company sells assets to reduce excess debt load
Corporate restructuring occurs:
Divisions and products are sold
Assets redeployed into new, higher-return areas

34. Leveraged Buyout (cont’d)
Investment bankers try to determine the ‘breakup value’ of a large company
This implies the value if all divisions are divided up and sold separately

35. International Investment Banking Deals
Privatization efforts across globe
Fraction of wealth owned by the state is higher
Much needed cash to build public services
Key companies owned by government in many countries
Privatization involves:
Investment bankers taking such companies public
The companies sold are formerly owned by governments rather individuals