14 1 B40 2302 Class 7 BM6 chapters 15 2 15 6 16 1 16 4 17 15 2 15 6 security issue process 16 1 16 4 dividend policy MM irrelevance 17 debt policy MM irrelevance Based on slides created by Matthew Will Modified 10 25 2001 by Jeffrey Wurgler Irwin McGraw Hill The McGraw Hill Companies Inc 200 Principles of Corporate Finance Brealey and Myers Sixth Edition How Corporations Issue Securities Slides by Matthew Will Jeffrey Wurgler Irwin McGraw Hill Chapter 15 2 15 6 The McGraw Hill Companies Inc 200 14 3 Topics Covered The Initial Public Offering The Underwriters Underpricing and The Winner s Curse General Cash Offers Irwin McGraw Hill The McGraw Hill Companies Inc 200 14 4 Initial Public Offering Initial Public Offering IPO First offering of stock to the general public Two kinds of public offerings Primary offering new shares are sold to raise cash for the company Secondary offering existing shares owned by VCs or firm founders are sold no new cash goes to company A single offering may include both of these Irwin McGraw Hill The McGraw Hill Companies Inc 200 14 5 Initial Public Offering Some benefits motivations Additional source of capital Increase debt capacity give breathing room for debt Stock prices give measure of performance Allows managers to be compensated with options or have incentives otherwise directly tied to shareholder value Potentially more information about firm analyst following makes borrowing cheaper Irwin McGraw Hill The McGraw Hill Companies Inc 200 14 6 Initial Public Offering Arranging an IPO First steps Select Underwriter provides procedural financial advice ultimately buys issue from company at issue price ultimately sells it to public at offer price Prepare Registration Statement for approval of SEC in accord with Securities Act of 1933 Formal summary that provides information on an issue of securities Prepare Prospectus Streamlined version of registration statement for consideration by potential investors Irwin McGraw Hill The McGraw Hill Companies Inc 200 14 7 Initial Public Offering Arranging an IPO Trying to set price Road show Talks organized to introduce company to potential investors before the IPO Bookbuilding Underwriter builds book full of indications of interest quantity price at which investors may be willing to buy List of likely orders Useful to set offer price Irwin McGraw Hill The McGraw Hill Companies Inc 200 14 8 Initial Public Offering Arranging an IPO Selling the shares Best efforts offering IPO method in which underwriter promises to sell as much as possible give best effort not commit to selling all of issue Or Firm commitment offering Method in which underwriter buys the whole issue bears all risk Irwin McGraw Hill The McGraw Hill Companies Inc 200 14 9 Initial Public Offering Arranging an IPO Selling the shares Syndicate Group of underwriters formed to sell a particular issue Spread Difference between public offer price and price paid by underwriter issue price Biggest part of underwriter compensation Irwin McGraw Hill The McGraw Hill Companies Inc 200 14 10 Top Underwriters Top U S Underwriters in 1997 bil of total issues Merrill Lynch Saloman Smith Barney Morgan Stanley 167 140 Goldman Sachs Lehman Brothers 137 121 JPMorgan Credit Suisse First Boston 104 68 Bear Stearns Donaldson Lufkin Jenrette 58 46 Chase All Underwriters Irwin McGraw Hill 208 33 1 293 The McGraw Hill Companies Inc 200 14 11 Top Underwriters Top Intl Underwriters in 1997 bil of total issues Merrill Lynch 37 Goldman Sachs 32 SBC Warburg 29 Deutsche Morgan 29 Credit Suisse First Boston 27 JPMorgan 24 Morgan Stanley 23 ABN AMRO Hoare 22 Lehman Brothers 18 Paribas 18 All Underwriters 496 Irwin McGraw Hill The McGraw Hill Companies Inc 200 14 12 Irwin McGraw Hill Tombstone The McGraw Hill Companies Inc 200 14 13 IPO Costs Three basic IPO costs 1 Administrative costs for preparing registration legal counsel preparing and printing prospectus etc 2 Spread 3 Underpricing Difference between what stock is offered at and what it s really worth Irwin McGraw Hill Can be measured roughly as end of first trading day price minus offer price A hidden cost but usually the biggest cost The McGraw Hill Companies Inc 200 14 14 IPO Costs Average costs on U S IPOs between 1990 1994 Value of Issues Direct Avg First Day Total mil Costs Return Costs Irwin McGraw Hill 2 9 99 16 96 16 36 33 32 10 19 99 11 63 9 65 21 28 20 39 99 9 7 12 48 22 18 40 59 99 8 72 13 65 22 37 60 79 99 8 2 11 31 19 51 80 99 99 7 91 8 91 16 82 100 199 99 7 06 7 16 14 22 200 499 99 6 53 5 70 12 23 500 and up 5 72 7 53 13 25 All Issues 11 00 12 05 23 05 The McGraw Hill Companies Inc 200 14 15 IPO Costs Why is there underpricing Several arguments Best one Winner s curse Suppose you apply for every IPO You will have no problem getting lots of shares in the bad firms the ones no one wants but when the issue is attractive there will not be enough to go around and you will receive less than you wanted of the good firms This is the winner s curse if you win an auction you are likely to have paid too much So you would lose on average You therefore need IPOs to be underpriced on average or else you will not play the game Irwin McGraw Hill The McGraw Hill Companies Inc 200 14 16 Public issues after the IPO Seasoned Offering SEO An equity issue by a firm after its IPO General Cash Offer Sale of securities open to all investors by an already public company Used for virtually all U S equity and debt issues Same procedure as IPO register with SEC sell issue to underwriter who sells issue to public Shelf Registration A procedure created by SEC Rule 415 that allows firms to file one registration statement for several issues of the same security Covers financing plans up to 2 years ahead Speeds up issue process don t have to issue all at once Usually used for relatively garden variety issues not complex issues where underwriter s stamp of approval may have value Irwin McGraw Hill The McGraw Hill Companies Inc 200 14 17 Public issues after the IPO Costs Direct costs spread administrative costs of issues after the IPO 2M Issue size 9 9M IPOs 17 SEOs 13 Convertible debt 8 Bonds 5 40M Issue size 59 9M IPOs 8 SEOs 6 Convertible debt 4 Bonds 2 500M Issue size IPOs 6 SEOs 3 Convertible debt 2 Bonds 1 Notice economies of scale Irwin McGraw Hill The McGraw Hill Companies Inc 200 14 18 Public issues after the IPO Costs Gross underwriter spreads of selected issues 1998 Type Company Issue amount millions of dollars Underwriter s spread percent