global equity financing - new york university stern...

Ian H. Giddy/NYU Global Equity Financing-1

Prof. Ian GiddyNew York University

Global EquityFinancing

Copyright ©2002 Ian H. Giddy Global Equity 2

Corporate Finance

CORPORATE FINANCEDECISONS


INVESTMENTINVESTMENT RISK MGTRISK MGTFINANCINGFINANCING

CAPITAL

PORTFOLIO

M&ADEBT EQUITY

TOOLS

MEASUREMENT



Corporate Finance




CAPITAL

PORTFOLIO

M&ADEBT EQUITY

TOOLS

MEASUREMENT


Corporate Finance




CAPITAL

PORTFOLIO

M&ADEBT EQUITY

TOOLS

MEASUREMENT

INVESTMENT

FINANCINGRISK

MANAGEMENT



Primary Market for Equities

Initial Public Offering (IPO)

Subsequent Offering

Private Equity Placement

Stock Buyback?

Management Buyout?


EquityBanking Fixed Income

Investment Banking: Organizarion

“Coverage”

•Corporate Finance•Mergers & Acquisitions•Investment Banking

Debt Capital Markets(DCM)

•Syndicate•Marketing

Sales•Institutional•Retail

Trading (proprietary)•Risk •Profits

Structured FinanceCredit ResearchPrivate PlacementLoan Syndication

Equity Capital Markets(ECM)

•Sales•Trading•Research



Investment Banking: Organization

New Deal Pitch Teaml Coverage/

Investment bankingl Product (DCM or

ECM)

Commitment Committeel Investment bankingl ECM/DCMl Senior sales/tradingl Research


Underwriting Sequence

l Engagement: Mandate signed by issuer engaging lead manager

l Due Diligence:Conducted by Lead manager

l Documentation: Loan agreement, Prospectus

l Signing: Underwriting agreement signed and issue priced

l Closing: Settlement of the offering

EngagementEngagement

Due Diligence andDocumentation

Due Diligence andDocumentation

Signing and PricingSigning and Pricing

ClosingClosing



The Beauty Contest

Criteria for Selecting a Lead Manager 1l Experience with similar transactions (sector,

market, currency, maturity, high or low-quality issuers)

l Ranking in League Tablesl Placement power with institutional and/or

retail investorsl Standing in secondary market as “market

maker” and commitment to secondary market trading


The Beauty Contest (Cont.)

Criteria for Selecting a Lead Manager 2l Quality/reputation of researchl Proposed marketing strategy (pricing,

timing, issue size, etc.)l Proposals for “Roadshow”l Relationships with potential co-

managersl Senior management commitment to

backing issue with people and capital



The Roadshow

l Organized by global coordinator and lead managers

l Informal presentation by management to potential investors

l Attendance limited to professional intermediaries and investing institutions

l Content must be consistent with information in draft version of prospectus or offering circular.


Syndication: The Structure

Lead ManagerBook-Runner

“International Coordinator

Joint Co-LeadManager

Joint Co-LeadManager

Joint Co-LeadManagers

LeadManager

LeadManager

LeadManagers

ManagerManager

Managers Selling Agent

Co-Lead Manager



Securities Underwriting: Relationships

Issuer

Agents Investment Bankers

Debt: Fiscal agent

Equity: Depositary institution

Lead manager/BookrunnerRegistered offering: Underwriting Agreement

Unregistered: Purchase Agreement

Co-managersAgreement Among Underwriters

Prospectus/Offering Circular

Institutional Buyers Retail Buyers


Subscription or Underwriting Agreementl Between issuer, global coordinator and all managersl Signed after pricing when “book-building” completedl Firm commitment to underwrite, subject to delivery of

certain confirmatory certificates and no “material adverse change” or “force majeure”

l Indemnity: By the issuer in favor of Global Coordinator and Managers against liability arising as a breach of warranty, material inaccuracy or omission

l Lock up: Issuer will not offer other securities for a period of time (eg six months)



Debt

Equity

Domestic market

Foreign market(Depositary Receipts)

BNY ADR Index

-7.47%-13.54%-19.28%

MSCI Index

-28.23%-25.64%-36.53%

AsiaLat AmerEmerging Markets

(1996-98)

What Form of Issue?


ADR (American Depository Receipts)

INVESTORS

LOCALDEPOSITARYINSTITUTION

U.S. BANK U.S. investor buys certificate which represents a foreign market security. It receives the same treatment as a U.S. security and trades freely in the U.S.

Holds shares of non-U.S. issuer on behalf of investors

NON-U.S.ISSUER

Non-U.S. issuer gains better access to U.S. market and may provide superior disclosure



Debt

Equity

Domestic market

Foreign market(Depositary Receipts)

Unsponsored Private placement

Exchange traded

Exchange traded IPO

Private placement IPO

Global issue or GDR

Depositary Receipts: Alternatives


Equity-Linked Eurobonds

l Eurobonds with warrantsl Convertible Eurobondsl Index-linked Eurobonds



Equity Financing Choices

Equity

Warrants Conver-tibles

ADRs Common


Pricing

Debt Instrumentsl Bonds priced according

to yield over benchmark (spread)

l Yield too low – issue does not sell

l Yield too high – too much given away

l Generally syndicate holds price for a day; in a successful issue yields gradually tighten

Equityl Mature issue: based on

current market price and market conditions, small premium for dilution; comparables

l IPO: comparables and discounted cash flow analysis



Pricing and Fees

The Businessn Telecomsn Dot-Comsn Avons(How much volatility?)

Debt

Equity

Fees

0.15%to1.5%

5% to7%

PricingT+SpreadL+Spread

Comparables/RatiosThe marketFuture cash flow

valuation

The Issuer


Relative Valuation

l Do valuation ratios make sense?• Price/Earnings (P/E) ratios

qand variants (EBIT multiples, EBITDA multiples, Cash Flow multiples)

• Price/Book (P/BV) ratiosqand variants (Tobin's Q)

• Price/Sales ratios

l It depends on how they are used -- and what’s behind them!



Valuing a Firm with DCF: An Illustration

Historical financial results

Adjust for nonrecurring aspects

Gauge future growth

Adjust for noncash items

Projected sales and operating profits

Projected free cash flows to the firm (FCFF)

Year 1 FCFF

Year 2 FCFF

Year 3 FCFF

Year 4 FCFF

Terminal year FCFF

Stable growth model or P/E comparable

Present value of free cash flows

+ cash, securities & excess assets

- Market value of debt

Value of shareholders equity

…

Discount to present using weighted average cost of capital (WACC)


Dividend Discount Models:General Model

VD

ko

t

tt

=+=

∞

∑ ( )11

lV0 = Value of StocklDt = Dividendl k = required return



Constant Growth Model

VoD g

k go

=+

−( )1

l g = constant perpetual growth rate


Constant Growth Model: Example

VoD g

k go

=+

−( )1

E1 = $5.00 b = 40% k = 15%(1-b) = 60% D1 = $3.00 g = 8%V0 = 3.00 / (.15 - .08) = $42.86

n Motel 6 has earnings of $5 per share. It reinvests 40% and pays out 60%dividend

n The required return that shareholders expect is 15%

n The earnings are expected to grow at 8% per annum

n What’s an M6 share worth?

n Motel 6 has earnings of $5 per share. It reinvests 40% and pays out 60%dividend

n The required return that shareholders expect is 15%

n The earnings are expected to grow at 8% per annum

n What’s an M6 share worth?

Plowback rate



Shifting Growth Rate Model

V Dgk

D gk g k

o o

t

tt

TT

T=++

++

− +=∑( )

( )( )

( )( )11

11

1

1

2

2

l g1 = first growth ratel g2 = second growth ratel T = number of periods of growth at

g1


The Investors’ Viewpoint:Equity Risk and Return

l Investors diversify, because you get a better return for a given risk.

l There is a fully-diversified “market portfolio” that we should all choose

l The risk of an individual asset can be measured by how much risk it adds to the “market portfolio.”

But does this apply to the global capital market?



The Weighted Average Cost of Capital

Choice Cost1. Equity Cost of equity

- Retained earnings - depends upon riskiness of the stock- New stock issues - will be affected by level of interest rates- Warrants

Cost of equity = riskless rate + beta * risk premium

2. Debt Cost of debt- Bank borrowing - depends upon default risk of the firm

- Bond issues - will be affected by level of interest rates- provides a tax advantage because interest is tax-deductible

Cost of debt = Borrowing rate (1 - tax rate)

Debt + equity = Cost of capital = Weighted average of cost of equity and

Capital cost of debt; weights based upon market value.

Cost of capital = kd [D/(D+E)] + ke [E/(D+E)]

Capital Asset Pricing Model (CAPM)

Bond Pricing

WACC


The Cost of Equity Depends on the Company’s Risk Premium

rj = RF + βj (rm - RF)where:rj = Required return on asset j;RF = Risk-free rate of return

βj = Beta Coefficient for asset j;rm = Market return

The term [βj(rm - RF)] is called the risk premium and (rm-RF) is called the market risk premium



International Equity Markets and Portfolio Diversification

l No well-accepted international version of the capital asset pricing model.

l The benefits of diversification globally are empirical issues.

l The empirical case for international diversification has two components.u Establish the riskiness of foreign investment, and the extent

to which combining a foreign with a domestic portfolio reduces risk.

u Even if it reduces risk, does foreign investment also reduce expected return?

l Then what we have to do is make sure we understand how international diversification is best achieved.


International Diversification Pays More

Portfolio

Risk

σkp

Number of Securities (Assets) in Portfolio1 5 10 15 20 25

TOTAL RISK

NONDIVERSIFIABLE RISK

DIVERSIFIABLE RISK



The Global Efficient Frontier

10 15 20 25 30 5 5

10

15

20

25

30

STOCKSANDBONDS

STOCKSONLY

EAFESTOCKS

& BONDS

EAFE STOCKS

WORLD STOCKS & BONDS

WORLD STOCKS

US STOCKS & BONDSUS STOCKS

US BONDS

AVERAGE RETURN% PA

RISK, % PA


Returns with FX

l Return in US is a function of two factors

1. Return in the foreign market

2. Return on the foreign exchange



Returns with FX

(1 + rUS) = (1 + rFM) (1 + rFX)

rUS = return on the foreign investment in US Dollars

rFM = return on the foreign market in local currency

rFX = return on the foreign exchange


Example

ROI with FX Change

Local currency ROI 17%Rate of change of the exchange rate -8%Foreign currency ROI 7.64%

Source: giddy.org

Web Resources


Prof. Ian GiddyNew York University

Raising and PricingEquity


Raising Equity: The Investment Banker’s Job

l Market conditionsl Corporate needsl Valuationl Informationl Distribution

TelekomTelekom



Deutsche Telekom: The Sequence

l See case Exhibit 2


What’s a Company Worthto Investors?

l Required Returnsl Types of ModelsuBalance sheet modelsuDividend discount & corporate cash flow

modelsuPrice/Earnings ratiosuOption models

l Estimating Growth Rates

TelekomTelekom



Equity Valuation: From the Balance Sheet

Value of Assetsn Bookn Liquidationn Replacement

Value of Liabilities

n BooknMarket

Value of Equity


Deutsche Telekom: Book Value

l See case Exhibit 3



Relative Valuation

l Do valuation ratios make sense?• Price/Earnings (P/E) ratios

qand variants (EBIT multiples, EBITDA multiples, Cash Flow multiples)

• Price/Book (P/BV) ratiosqand variants (Tobin's Q)

• Price/Sales ratios

l It depends on how they are used -- and what’s behind them!


Deutsche Telekom:Ratios and Comparables

l See case page 9



Discounted Cashflow Valuation: Basis for Approach

uwhereu n = Life of the assetu CFt = Cashflow in period tu r = Discount rate reflecting the riskiness of

the estimated cashflows

Value = CFt

(1+r)tt=1

t=n∑


Deutsche Telekom: Earnings

l See case page 8



Valuing a Firm with DCF: An Illustration

Historical financial results

Adjust for nonrecurring aspects

Gauge future growth

Adjust fornoncashitems

Projected sales and operating profits

Projected free cash flows to the firm (FCFF)

Year 1 FCFF

Year 2 FCFF

Year 3 FCFF

Year 4 FCFF

Terminal year FCFF

Stable growth model or P/E comparable

Present value of free cash flows

+ cash, securities & excess assets

- Market value of debt

Value of shareholders equity

…

Discount to present using weighted average cost of capital (WACC)


What’s a Company Worth?Alternative Models

l The options approachuOption to expanduOption to abandon

l Creation of key resources that another company would pay foruPatents or trademarksuTeams of employeesuCustomers

l Examples?

LycosLycos

Messageclick.comMessageclick.com



Raising Equity: The Investment Banker’s Job

l Market conditionsl Corporate needsl Valuationl Informationl Distribution

TelekomTelekom

T-OnlineT-Online


Contact

Ian H. GiddyNYU Stern School of Business44 West 4th Street, New York, NY 10024, USATel [email protected]://giddy.org

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