Chapter 16 How corporations issue securities

Venture capital

Money invested to finance a new firm. These new firms rely initially on family funds and bank loans, while some of them continue to grow with the aid of equity investment provided by wealthy individuals known as angel investors. Entrepreneurs start a venture capital firm raising funds from savings, personal bank loans and shares purchased in the new enterprise. This stage is called a zero stage investment. When the business plan impresses other investors, they may buy shares in the venture capital firm, and this is the first stage financing. Funds are usually dispersed in stages, after a certain level of success is achieved. Though some venture capital firms are successful and investors could earn more than what could be earned in a large public firm, however investing in a venture capital firm bears extra risks.

The Initial Public Offering (IPO) ( when the company first go public)

First offering of stock to the general public. Companies make IPO to raise new capital or to enable shareholders to cash out. You should not have the impression that all firms go public. It is common in some countries for even large business to remain privately held than going public. Arranging an IPO: 1- Management first task is to select the underwriter (Firm that buys an issue of securities from a company and resells it to the public for a spread). 2- Registering the securities issue with the SEC by submitting a registration statement describing the proposed financing. The most important sections of the statement are distributed to investors in a prospectus (Formal summary that provides information on an issue of securities). 3- The issue must comply with the blue-sky laws of each state. The Sale of stocks

The company and the underwriter arrange a road show to talk with potential investors, seeking for reactions on the issue and how much stocks investors wish to buy. The price of stock is thereafter determined, and the underwriter markets and sells the stocks to the public realizing a spread (Difference between public offer price and price paid by underwriter). This spread is expected to decline with issue size ( for example: a 5 million issue might be 10 % spread, while a 300 million might be 5% spread).

Underpricing of IPO

(Issuing securities at an offering price set below the true value of the security). You of course think now that underpricing come at the expense of the issuing firm ! Some researchers think like you, however, others believe that underpriced IPO is in the interests of the issuing company, because a low offering price raises the price when the securities are traded in the market and enhances the firms ability to raise further capital.

Book-building method and auctions:

The book-building method aims to gather indications for the prices of shares from potential investors, however these prices are not binding and merely used as a guide to fix the price. In auctions, investors are invited to submit bids on the stock price, and the securities are subsequently sold to the highest bidders. Types of auction

1- Discriminatory auction: An auction in which the winning bidders are required to pay the price they bid. Overbidding is risky in this type of auction. In a discriminatory auction of 150 bonds If A bids 10000 each $ for 100 bonds , B bids 9000 each $ for 50 bonds, and C bids 3000 $ for 30 bonds, the winning two bidders A and B must pay 10000 and 9000 respectively. 2- Uniform auction: An auction in which the price to be paid is the price of the lowest winning bidder. There is a little cost of overbidding. In the previous example A and B would pay 9000 $ for each bond. General Cash Offer

Sale of securities open to all investors by an already public company. The general cash offer is costly in the spread obtained by underwriters. Shelf Registration - A procedure that allows firms to file one registration statement for several issues of the same security. International security issue: Issuing securities in another countrys domestic market. This kind of issue is governed by the rules of that country. Private Placement - Sale of securities to a limited number of investors without a public offering.

Market reactions to stock issue:

The announcement of stock issue usually results in a decline in the stock price, why? Because investors predict that managers are more likely to announce new issue when they think it is overvalued, therefore when a new issue is announced, investors mark down the price.

Rights Issue

Issue of securities offered only to current stockholders.

Example-1 - BNP Paribas Bank needs to raise 5.50 billion of new equity. The market price is 77.40/sh. It decides to raise additional funds via a 1 for 10 rights offer at 65.40 per share. If we assume 100% subscription, what is the value of each right? Current Market Value = 10 x 77.40 = 774.00 Total Shares = 10 + 1 = 11 Amount of funds = 774 + 65.40 = 839.40 New Share Price = (839.40) / 11 = 76.31 Value of a Right = 76.31 65.40 = 10.91

Example 2- BNP Paribas bank needs to raise 1.28 billion of new equity. The market price is 60/sh. Lafarge decides to raise additional funds via a 4 for 17 rights offer at 41 per share. If we assume 100% subscription, what is the value of each right? Current Market Value = 17 x 60 = 1,020 Total Shares = 17 + 4 = 21 Amount of funds = 1,020 + (4x41) = 1,184 New Share Price = (1,184) / 21 = 56.38 Value of a Right = 56.38 41 = 15.38