TBS 907- Autumn 2005- Lecture 8- Capital Markets- Updated

TBS 907- Autumn 2005- Lecture 8- Capital Markets- Updated -...

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Unformatted text preview: TBS 907 AUTUMN 2005 LECTURE 8 CAPITAL MARKETS Definition of Capital Market Definition of Capital Market The market in which financial securities are traded. The suppliers and users of funds can negotiate the conditions on which funds will be transferred. This transfer can be done in either the debt or equity market. It is the debt and equity markets together which form the capital market. Patterns of Corporate Financing Firms may raise funds from external sources or plow back profits rather than distribute them to shareholders. Should a firm elect external financing, they may choose between debt or equity sources. Equity Firms may raise finance through Equity Common Stock/ Ordinary Shares Preference Shares ( Hybrid Debt and Equity) Voting Rights One Shares One Vote Proxies Super Majority Cash Flow v/s voting rights Different Voting Rights for different Classes Private Benefits of Control Holdings of Corp Equities (2004) Rest of World 10.4 Mutual Funds, etc. 21.0 Other 3.2 Households 36.8 Insurance Companies 7.4 Pension Funds 21.1 Percent of Holdings Preferred Stock Preferred Stock Stock that takes priority over common stock in regards to dividends. Net Worth Book value of common shareholder's equity plus preferred stock. FloatingRate Preferred Preferred stock paying dividends that vary with short term interest rates. Corporate Debt Debt has the unique feature of allowing the borrowers to walk away from their obligation to pay, in exchange for the assets of the company. "Default Risk" is the term used to describe the likelihood that a firm will walk away from its obligation, either voluntarily or involuntarily. "Bond Ratings"are issued on debt instruments to help investors assess the default risk of a firm. Corporate Debt US dollar debt Bank loans Notes Guaranteed Notes Unsecured debentures Revenue bonds Remarketable securities Eurodollar notes Senior eurobonds Foreign currency debt Sterling notes Euro notes New Zealand dollar notes TABLE 14-5 Large firms issue many different securities. This table shows some of the debt securities on Heinz's balance sheet in April 2003. CORPORATE DEBT Should the company borrow longterm or short term? Should the debt be fixed or floating rate? Should you borrow dollars or some other currency? What promises should you make to the lender? Should you issue straight or convertible bonds? Holdings of Corp Debt (2004) Other 9.1 Banks 9.0 Households 14.3 Pension Funds 10.3 Rest of World 18.9 Mutual Funds, etc. 11.7 Insurance Companies 26.6 Percent of Holdings Financial Markets Money Primary Markets Secondary Markets OTC Markets Financial Institutions Company Obligations Funds Intermediaries Banks Insurance Cos. Brokerage Firms Financial Institutions Intermediaries Obligations Funds Investors Depositors Policyholders Investors How Corporation Issue Securities Venture Capital The Initial Public Offering Other NewIssue Procedures Security Sales by Public Companies Rights Issue Private Placements and Public Issues Venture Capital Venture Capital Money invested to finance a new firm Since success of a new firm is highly dependent on the effort of the managers, restrictions are placed on management by the venture capital company and funds are usually dispersed in stages, after a certain level of success is achieved. U.S. Venture Capital Investments 120 100 106.2 $ Millions 80 60 40 20 0 7.6 1995 11.5 14.8 21.2 21.2 18.4 54.4 40.7 3.7 1993 4.2 1994 1998 1999 2001 1996 1997 2000 2002 2003 Initial Offering Initial Public Offering (IPO) First offering of stock to the general public. Underwriter Firm that buys an issue of securities from a company and resells it to the public. Spread Difference between public offer price and price paid by underwriter. Prospectus Formal summary that provides information on an issue of securities. Underpricing Issuing securities at an offering price set below the true value of the security. Mechanics of an IPO Mechanics of an IPO A float is the term given to the company's first invitation for the public to subscribe for shares an initial public offering (IPO). For stock exchange listing, the company needs to satisfy the listing requirements of the exchange. A prospectus is required a legal document that provides details of the company and the terms of the issue of shares. Equity Financing Equity Financing Flotation of a business the players: promoters advisers underwriters subunderwriters Stock Exchange Regulators brokers institutions, private individuals, foreign investors Pricing a New Issue Pricing a New Issue Difficult if there is no earnings record as historic earnings are commonly used as the basis for estimating future earnings. Advisers consider priceearnings ratios of existing companies in the same industry. Fixed price offer versus open pricing. Available evidence suggests `underpricing' of IPOs, on average. Underwriting a New Issue Underwriting a New Issue Service provided by a stockbroker or merchant bank. For a fee, the underwriter contracts to purchase all shares for which applications have not been received by the closing date of the issue. Underwriter can limit exposure by sub underwriting. The Costs of Issuing Securities The Costs of Issuing Securities Direct Expenses: issuer Filling fees, legal fees, taxes. Underwriter's Spread: offer price the price received by the Indirect Expenses: cost of management's time spent Abnormal Returns: stock prices drop after the issue (SEOs Seasoned Equity Offering) Underpricing: shares sold at price below market (IPOs) Overallotment (Green Shoe): underwriters have the right to buy additional shares at the offer price to cover excess demand The Costs of IPO The Costs of IPO Vary widely, usually 35 per cent of the amount raised. Costs include: adviser's fee for structuring, valuation and preparation of the documentation legal and accounting fees, printing costs Stock Exchange listing fees underwriter's fee The Costs of IPO The Costs of IPO Underpricing Well documented underpricing of IPOs. Possible reasons for underpricing: Underpricing is necessary to attract investors who have difficulty estimating the future market price of the shares being offered (winner's curse). Underpricing is necessary to induce some potential investors to buy, which may set off a cascade in which other investors are willing to subscribe. Underpricing leaves a good taste with investors, raising the price at which subsequent share issues by the company can be sold. Initial Public Offering Details IPO Date: First Trade: Price: Method: Lead Underwriters: Stock Symbol: Exchange: No. of Shares Offered: Value of Offering: Initial Market Cap: Total Initial Shares Outstanding: Allocation Percentage: Initial SEC Filings: August 19, 2004 11:56 am ET at $100.01 $85.00 Modified Dutch Auction Morgan Stanley, Credit Suisse First Boston GOOG NASDAQ 19,605,052 $1.67 billion $23.1 billion 271.2 million (33.6 mil. class A, 237.6 mil. class B) 74.2% of bidded shares Form S-1 Prelim. Prospectus (amend. 8/18) Average Initial IPO Returns Canada Netherlands Spain France Australia Hing Kong UK USA Italy Germany Japan Singapore Sweden Taiwan Mexico Switzerland India Greece Korea Brazil China 257 % 0 20 40 60 80 100 return (percent) General Cash Offers Seasoned Offering Sale of securities by a firm that is already publicly traded. General Cash Offer Sale of securities open to all investors by an already public company. Shelf Registration A procedure that allows firms to file one registration statement for several issues of the same security. Private Placement Sale of securities to a limited number of investors without a public offering. Rights Issue Rights Issue Issue of securities offered only to current stockholders. Example Lafarge Corp needs to raise 1.28billion 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? Rights Issue Example - Lafarge Corp needs to raise 1.28billion 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 Valuation of Rights Valuation of Rights As the subscription price is at a discount to market price, theoretically there should be a downward adjustment in the share price when it is traded ex rights compared to cumrights. The ex rights price should fall by the value of the right attached to each share. Valuation of Rights (cont.) Valuation of Rights (cont.) N (M S) Value of Right (R) = N + 1 where N = number of shares required to be entitled to one new share M = market price of a share cumrights S = subscription price Rights Value Rights Value The market price of a share exrights (X): NM +S X = N + 1 Theoretically, a rights issue has no value to shareholders. The announcement can have an impact on shareholders' wealth. ...
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