Beruflich Dokumente
Kultur Dokumente
Corporate Finance
Roberto Mura
roberto.mura@mbs.ac.uk
https://www.research.manchester.ac.uk/portal/Roberto.Mura.html
www.robertomura.com
Semester II 2017
1
A bit about myself
• Associate Professor (S. L.) in Finance
• Director of MSc Finance (used to be director
of F&E and FBE)
• Acting Director of all MAFG PGT
• PhD in Economics (University of York) but I
specialise in Corporate Finance
• Research interests: ownership structure of
firms, financial structure, determinants of
performance, risk taking, banking, M&As,
credit ratings, behavioral finance
2
A bit about myself: Research
• Some Key Publications (“orthodox”)
– Shareholder diversification and bank risk-taking, Journal
of Financial Intermediation
• Semifinalist for the Best Paper Award at FMA 2013 Chicago.
– Shareholder diversification and corporate risk-taking,
Review of Financial Studies
• Black Rock/Brennan Award for outstanding paper in the
Review of Financial Studies
• Semifinalist for the Best Paper Award at FMA 2010 New York.
– Financial Flexibility, Investment Ability and Firm
Value: Evidence from Firms with Spare Debt Capacity,
Financial Management
3
A bit about myself: Research
• Some Key Publications (less “orthodox”)
– CEO Gender, Corporate Risk-Taking, and the Efficiency
of Capital Allocation
4
A little bit about myself
• Teaching Experience:
– Capital Markets (UG)
– Corporate Finance UG/PGT/PhD
– Financial Management and Project Appraisal (PGT)
– M&A negotiations (MBA)
– Stata PGT/PhD
5
Office Hours-SOHOL
• Staff are usually available for office hours to
answer questions or offer support
• You typically book this through SOHOL
6
Overview
7
Case Studies
• There are three case studies. These are meant to
link theory with practice
- L&H Speech Products (IPO)
- Arcelor Undervaluation (Capital Structure)
- Accounting Fraud & Restoring Trust at Worldcom
(Corporate Governance)
11
Aims of the Course
• Provide knowledge of core issues in CF
• Develop an analytical way of thinking!
• We want to learn about the “real world” but in Social
Sciences we have a big “handicap” compared with
Empirical Scientists:
– What is it?
13
Aims of the Course
• In this sense the knowledge and skills you will
acquire with this module link very well with other
(econometric) modules in your MSc
‒ M&As
‒ Current Issues in Empirical Finance
‒ Portfolio Investment
‒ Time Series Econometrics
‒ Business Economics
• Also, they will prove crucial for the MSc
Dissertation (60 Credits)
• In your future (professional) life, this training to
analytical thinking will prove invaluable!
14
Lecture 1
The Sale of Equity Securities
(IPOs and SEOs)
15
Overview of Today’s class
• What are the sources of capital?
– Internal funds
– External Capital:
• Equity
• Debt
• Hybrids
• How to raise equity capital?
• Listing on the stock exchange IPOs
• Anomalies associated with IPOs
• How to Value an unlisted stock Tutorial
16
External Capital: Debt vs Equity
17
Debt vs Equity
• Bondholders:
– Contracted claims
– Priority claim must be met in full before equity holders
– Interest payments are costs and are tax-deductible
– Fixed maturity
– Passive (some veto power covenants)
• Shareholders (owners):
– Dividends (firm not obliged Microsoft 28 years
before 1st dividend in 2003)
– Residual claims
– Dividends are profits and so they are taxed
– No maturity
– Voting rights 18
Typical “Timeline”
Birth Maturity
Public debt and
LARGE
equity markets
Longer-term (bank) debt
MEDIUM
Later stage PE (“VC”)
Early stage VC, short-term debt
Friends, family, business angels SMALL
Self financed
19
Venture Capitalists
• Companies specialized in raising money to invest in the
private equity of young firms:
– Typically set up as Limited Partnerships
– Limited Partners put the capital (Institutional Investors)
– General Partners run the VC firm 1.5-2.5%
management fees + 20/30% of profits
– GPs know the mkts where they invest very well they
target young high growth firms
• Recently the focus has been on internet and high tech
firms see Case Study 1
– LPs can have a more diversified investment with high
upside potential (high risk)
20
‒ Required rate of return on investment is high: between 5
to 20 times the initial investment in about 5-7 years
21
• The most typical exit strategy for VCs is to take firms
public: IPO
• Two types of shares can be sold in an IPO:
– Primary (new shares)
– Secondary (held by existing owners)
• After listing firms can do SEOs.
• In the UK a rights issue is the most prevalent method
23
Reasons not to go Public?
• Expensive undertaking
– Management fees to UWs
– Underpricing (on average 15%)
• Increase in legal requirements (Corporate Governance)
– There is increasing evidence that the SOX Act has lead
numerous firms to delist from NYSE and list elsewhere
(AIM)
• Stock price emphasis may lead to short-termism
• Increased Agency Costs (liquidity vs control)
• Increased risk of Takeover
• Higher information disclosure obligation to divulge
information (i.e. annual reports) and inform your rivals
24
• We could summarize all this with
– Their first cheque came from a Business Angel who
had no idea himself how the “PageRank” algorithm
would eventually generate money
– Then 2 big players in the VC world came along,
Kleiner Perkins Caufield & Byers and Sequoia
Capital who chipped in 12.5 million each
– When they did that, they immediately required seats
on the BoD and the appointment of an external CEO
– KPCB managed to have Google appoint a CEO of
their liking (Eric Schmidt)
25
– Google however, required a personal investment
from the future CEO as a token of commitment to
the firm (until April 2011 he was still the CEO and
is still Exec CH)
– After 6 years from the first cheque Google went
public in NASDAQ (in a very original way)
– They issued dual class shares: Class A shares 1
share 1 vote while the founders retained Class B 1
share 10 votes in order to retain control
– The original investment by VCs of 25mil became 4
Billion at float
– Google said that one of the most important reason
for going public was to provide liquidity to its
26
employees and senior management
The process of IPOs
• Enlist an investment bank to “underwrite” the issue
• Often UWs work in syndicates
– In this case one bank will be the lead underwriter or book
runner and the others are co-managers.
– this may ensure higher analyst coverage post IPO
• UWs perform numerous tasks:
‒ Help the firm with all the legal documents, especially the
registration statement and the prospectus
‒ This contains pretty much everything you should know about the
firm (see L&H’s prospectus, Case Study 1)
‒ Estimate the value of the securities it will sell on behalf of
the firm (clearly much easier for debt and SEOs than IPOs)
‒ Advise the firm on various aspects such as BoD, method of
floating, timing of the issue
27
Pricing IPOs
Book Building vs Fixed Price
• “Road Show”: once the initial price range has been set,
UWs start the “road show” to promote the stock with
some of their largest customers
• “Book Building Method”: during the road show, the
UW builds a “book” of non-binding orders for the stock
• These bids (how many shares they would like to buy and
at what price) allow UWs to have a “demand
function” for the stock
‒ relatively easy to set a clearing price/total number of
shares for the IPO
• It is not uncommon however that the price is fixed in
advance (“Fixed Price Method”)
28
UWR Commitment
• Firm Commitment: The UWRs typically will have to
buy all the shares from the company so it is in its best
interest to sell them all in the market
– For this reason the investment banker has the incentive
to oversubscribe the IPO
29
Cost of IPO
Security Type Average Number Total Gross Fees
Fee (%) of issues ($ Millions)
Debt
Corporate Investment Grade 0.758 226 504
Common Stock
https://site.warrington.ufl.edu/ritter/files/2016/01/Gross-Spread-for-Moderate-Size-IPOs-1980-2012.pdf
31
Who gets the shares?
• The lead UW has a certain discretion about the
distribution of shares among its clients.
• This can create a number of problems. For instance,
EBAY used Goldman Sachs as an UW.
• It later emerged that the CEO and CH of EBAY in the
past had received shares of other (underpriced) IPOs
where GS was the UW which they could resell for a
large profit (this is called spinning).
• So the CEO and CH of EBAY chose GS as an UW for
the IPO in a sort of “quid pro quo”.
• EBAY’s shareholders then sued the CEO and CH and
received near 3.5 million compensation.
32
Who gets the shares?
• Also, the bank may engage in price stabilization after
listing if the new issue is faltering
• It is rather uncommon (but Google did it this way) to
have an online auction to set the price
– This is called “Open IPO”
• Suppose that Google wants to sell 500,000 shares in
the market
• Investors place bids online opening an account through
the UW. Suppose that this demand function looks like
this:
33
Share Price Number of Shares Cumulative
Demand
£8 25,000 25,000
£7 150,000 500,000
Spread 7%
Discretionary
Allocation of shares
Fixed Fee
Green Shoe
Syndicate
36
PRIMARY
SECONDARY SHARES
SHARES
CLASS A
CLASS B VR≠ CR
Spread
2.805%
Green Shoe
Auction
Syndicate
37
Spread 3.25%
Green Shoe
Syndicate 38
Greenshoe
• Suppose that firm A goes public using UW U
• A and U set the price at £12 and the spread is £1 and 100
shares are made available to the market
41
Short Run Underpricing
• The ‘short-run’ is usually taken as the first day of
trading or the first week of trading and sometimes the
first month of trading
• The return for stock ‘i’ at the end of the first trading
day is calculated as:
Pi1 is the price of the stock ‘i’ at the close of the first
trading day, Pi0 is the offer price and Ri1 is the total
first-day return on the stock
42
Average first-day returns on (mostly) European IPOs
60%
50%
Average first-day returns
40%
30%
20%
10%
0%
125%
Average first-day returns
100%
75%
50%
25%
0%
700 70
600 60
500 50
400 40
300 30
200 20
100 10
0 0
Number of Offerings (bars) and Average First-day Returns (line) on US IPOs, 1980-2015
Source: Jay Ritter, University of Florida, using data from Dealogic and Thomson Reuters. Only
operating company IPOs with an offer price of at least $5 per share are included. Banks and
S&Ls, natural resource limited partnerships, and ADRs are also not counted.
45
Number of Offerings and Average First-Day Returns on German IPOs, 1980-2011
Number of Offerings and Average First-day Returns on UK IPOs, 1980-Oct. 2011
49
Quick Example
NYSE Composite Index
Date Open High Low Close
06/11/2013 10045.12 10083.47 10034.22 10059.49
07/11/2013 10068.96 10072.05 9920.31 9924.37
08/11/2013 9911.97 10032.82 9909.54 10032.14
11/11/2013 10029.14 10049.39 10008.94 10042.94
12/11/2013 10022.58 10037.62 9982.29 10009.82
13/11/2013 9969.45 10079.89 9963.74 10079.89
14/11/2013 10079.28 10135.28 10071.71 10130.51
53
Reasons for Underpricing:
Signalling
• Issuers have an incentive to underprice, to leave a
“good taste” with investors (The Google Story,
pg.169!!!)
54
Reasons for Underpricing:
Signalling
• Buying at a low prices and then seeing P increase will
be a signal of a good investment for buyers
55
Test your knowledge
56
Test your knowledge
57
There are many more…
• Underpricing as a form of insurance (Tinic, 1988)
– window dressing of the accounts
58
Empirical Literature
• Why do companies go public?
59
Empirical Literature
• Survey study by Brau and Facett (2008)
• Data from 37 withdrawn IPOs, 87 successful IPOs and
212 firms that are large enough that they could go
public
60
Reasons to go Public
61
Reasons not to go Public Liquidity
vs
Control
62
Reasons for Underpricing
63
Signalling
64
Long Returns on IPOs during
the five years after issuing, US (1980-2014)
20
18
16
14
12
10
8
6
4
2
0 SIZE
Year1 MATCH
Year2
Year3 IPO
Year4
Year5
Source: https://site.warrington.ufl.edu/ritter/files/2016/03/Initial-Public-Offerings-
65
Updated-Statistics-on-Long-run-Performance-2016-03-08.pdf
Measures of LRUP
• Market adjusted buy and hold returns for a firm i
(MABHRi) are calculated as follows
t 36 t 36
MABHRi 1 Ri ,t 1 Rm,t
t 1 t 1
68
http://www.wsj.com/mdc/public/page/2_3021-lockupexp.html
Lock-in agreements
69
• Why do lock-ins exist?
– Signalling hypothesis: High(er) quality firms should be
able to have longer lock-ins (Brav-Gompers, 2003)
• Insiders (managers) hold undiversified portfolios. So,
restricting the sale of stock for a longer period of time
imposes a cost on them
71
How Investment Bankers
Value Companies
72
Source: Dennis and Cain, 2009
1) The Free Cash Flow Approach
The estimated current market value of debt and equity
(V) i.e. the total firm value is given by
n
[ Freecashflow]t Vn
V
t 1 (1 WACC ) t
(1 WACC ) n
73
• First, we need to identify the correct measure of FCF
• In general, we try to look for the “free cash flow to the
firm” which will allows us to estimate the value of the
firm (not of its equity alone):
• So we use the cash flow to all claimholders
FCF=EBIT(1-t)+DEPR-CAPEX-NWC+other
EBIT = Earnings before interest and Taxes
t = corporate tax rate
DEPR = depreciation charges
CAPEX = capital expenditures
NWC = increases in net working capital
other = wages payable (stock based compensation)
74
• Second, we need to identify the appropriate discount factor
E D
WACC re rd 1 c
V V
• We assume for simplicity that WACC remains constant
• Vn can be estimated as a growing or constant perpetuity
75
Steps involved in the DCF approach
76
• Step 2. We then need to calculate the WACC of
the firm.
E D
WACC r r (1 - T )
e V d c V
77
• We estimate the levered beta of the firm by using the
following Hamada equation:
D
L u[1 (1 Tc ) ]
E
78
• Step 3. We then need to make an assumption about
the growth rate of the revenues, beyond the planning
horizon and then use Gordon's formula to find the
terminal value of the firm (Vn). The terminal value
of a firm is calculated as:
79
• Step 4. Having calculated the FCF, WACC and Vn,
we use the given formula to calculate the total value
of the firm at the time of the IPO.
80
• This method has numerous advantages
– It recognizes the time value of cash flows
– It is future oriented and estimates what an owner
may achieve in the future
• However
– Forecasting of cash flows can be very difficult
– Same is for growth rate of cash flow and therefore
the terminal value
– Always hard to find “peer companies”
81
2) The ‘comparable firms’ approach
• How do you decide how much a house is worth?
• Most likely you look at recent sale of similar homes
in the neighbourhood
• Likewise, analysts and investment bankers get a
rough idea about the value of a firm by looking at
market prices of similar firms that are listed
• Steps:
– Identify a set of peer companies
– Work out ‘average’ P/E or P/S or (and) M/B ratios
– Apply these to estimates of EPS or BE for the firm
undertaking the IPO.
82
• The financial press seemed to associate these firms to
Twitter as “peers”: Amazon, Facebook, Groupon,
Linkedin, Netflix, Yelp, Zinga.
Book Value
Company Name SIC MB MS Sales Twitter Twitter SharesTwitter
Amazon.com Inc 5961 15.758 2.930 422,215,000 705,045,000 70,000,000
Facebook Inc 7370 9.443 23.310 422,215,000 705,045,000 70,000,000
Groupon Inc 7370 9.232 4.147 422,215,000 705,045,000 70,000,000
LinkedIn Corp 7370 11.594 27.140 422,215,000 705,045,000 70,000,000
Netflix Inc 7841 15.214 5.727 422,215,000 705,045,000 70,000,000
Yelp Inc 7370 22.227 26.896 422,215,000 705,045,000 70,000,000
Zynga Inc 7372 1.596 4.289 422,215,000 705,045,000 70,000,000
Price
Average MS 13.49116 5,696,168,853 81.37
Median MS 5.727185 2,418,103,415 34.54
Industry (7370)
median MS 4.202176 1,774,221,740 25.35
84
The VC Method
• VCs often deal with firms at very early stages of their
life cycle.
– Often firms lose money in their early stages
• Also, since they are very young, the time series of data
available is very limited
• Entrepreneurs are, by nature very optimistic. Their
forecasts of future earnings may not be very reliable
• So, given that they invest in so many risky projects, the
typical required rate of return VCs demand is very high
• They use the traditional methods of peer valuation or
DCF but, they won’t use WACC to discount
– Rather, they use their own required rate of return
85
• For instance, “Man United.plc” intends to go public in
3 years time
• Suppose that the earnings of MU are expected to be
fixed at 4 mil in next 3 years
• Suppose that, on average, the P/E ratio of similar (but
listed) firms is 25, then MV=100.
• Discount this to PV using the “target” discount factor
– Suppose MU is perceived as mildly risky by VCs, and
they would require a 30% return
Estimated Exit Value
Disc Terminal Value= (1+ Target Rate of Return) n
100
3
45.52
DTV = (1+0.3) 86
• Now the structure of the deal can be worked out.
• For instance, how much money is the VC prepared to
put in the firm and for what fraction of the equity?
• Assume that our VC is prepared to put 15 million into
MU, then the fraction of equity they will require is
approx 33%
15
– Ownership Proportion = 45.52 0.329 control
88