Global Equity Financing Prof Ian Giddy New York

Global Equity Financing Prof. Ian Giddy New York University

Corporate Finance CORPORATE FINANCE DECISONS INVESTMENT FINANCING PORTFOLIO CAPITAL M&A Copyright © 2002 Ian

Corporate Finance CORPORATE FINANCE DECISONS INVESTMENT PORTFOLIO CAPITAL M&A Copyright © 2002 Ian H.

Primary Market for Equities Private Equity Placement Initial Public Offering (IPO) Subsequent Offering Stock

Investment Banking: Organizarion Banking “Coverage” • Corporate Finance • Mergers & Acquisitions • Investment Banking Fixed Income Debt Capital Markets (DCM) • Syndicate • Marketing Sales Equity Capital Markets (ECM) • Sales • Trading • Research • Institutional • Retail Trading (proprietary) • Risk • Profits Structured Finance Credit Research Private Placement Loan Syndication Copyright © 2002 Ian H. Giddy Global Equity 6

Investment Banking: Organization New Deal Pitch Team l Coverage/ Investment banking l Product (DCM or ECM) Copyright © 2002 Ian H. Giddy Commitment Committee l Investment banking l ECM/DCM l Senior sales/trading l Research Global Equity 7

Underwriting Sequence l l l Engagement: Mandate signed by issuer engaging lead manager Due Diligence: Conducted by Lead manager Documentation: Loan agreement, Prospectus Signing: Underwriting agreement signed and issue priced Closing: Settlement of the offering Copyright © 2002 Ian H. Giddy Engagement Due Diligence and Documentation Signing and Pricing Closing Global Equity 8

The Beauty Contest Criteria for Selecting a Lead Manager 1 l Experience with similar transactions (sector, market, currency, maturity, high or low-quality issuers) l Ranking in League Tables l Placement power with institutional and/or retail investors l Standing in secondary market as “market maker” and commitment to secondary market trading Copyright © 2002 Ian H. Giddy Global Equity 9

The Beauty Contest (Cont. ) Criteria for Selecting a Lead Manager 2 l Quality/reputation of research l Proposed marketing strategy (pricing, timing, issue size, etc. ) l Proposals for “Roadshow” l Relationships with potential comanagers l Senior management commitment to backing issue with people and capital Copyright © 2002 Ian H. Giddy Global Equity 10

The Roadshow 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. l Copyright © 2002 Ian H. Giddy Global Equity 11

Syndication: The Structure Lead Manager Book-Runner “International Coordinator Co-Lead Manager Joint Co-Lead Managers Lead Managers Managers Copyright © 2002 Ian H. Giddy Selling Agent Global Equity 12

Securities Underwriting: Relationships Issuer Agents Debt: Fiscal agent Equity: Depositary institution Investment Bankers Lead manager/Bookrunner Registered offering: Underwriting Agreement Unregistered: Purchase Agreement Co-managers Agreement Among Underwriters Prospectus/Offering Circular Institutional Buyers Copyright © 2002 Ian H. Giddy Retail Buyers Global Equity 13

Subscription or Underwriting Agreement l l l Between issuer, global coordinator and all managers Signed after pricing when “book-building” completed Firm commitment to underwrite, subject to delivery of certain confirmatory certificates and no “material adverse change” or “force majeure” Indemnity: By the issuer in favor of Global Coordinator and Managers against liability arising as a breach of warranty, material inaccuracy or omission Lock up: Issuer will not offer other securities for a period of time (eg six months) Copyright © 2002 Ian H. Giddy Global Equity 14

What Form of Issue? Debt Equity Domestic market Asia Lat Amer Emerging Markets Copyright © 2002 Ian H. Giddy Foreign market (Depositary Receipts) BNY ADR Index MSCI Index (1996 -98) -7. 47% -28. 23% -13. 54% -25. 64% -19. 28% -36. 53% Global Equity 15

ADR (American Depository Receipts) U. S. BANK Holds shares of non-U. S. issuer on behalf of investors LOCAL DEPOSITARY INSTITUTION Copyright © 2002 Ian H. Giddy 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. Non-U. S. issuer gains better access to U. S. market and may provide superior disclosure INVESTORS NON-U. S. ISSUER Global Equity 16

Depositary Receipts: Alternatives Debt Equity Domestic market Foreign market (Depositary Receipts) Unsponsored Private placement IPO Copyright © 2002 Ian H. Giddy Exchange traded Global issue or GDR Exchange traded IPO Global Equity 17

Equity-Linked Eurobonds l Eurobonds with warrants u. Marui l Convertible Eurobonds u. Battle l

Equity Financing Choices Warrants Convertibles Equity ADRs Copyright © 2002 Ian H. Giddy Common

Pricing Debt Instruments l l Bonds priced according to yield over benchmark (spread) Yield too low – issue does not sell Yield too high – too much given away Generally syndicate holds price for a day; in a successful issue yields gradually tighten Copyright © 2002 Ian H. Giddy Equity l l Mature issue: based on current market price and market conditions, small premium for dilution; comparables IPO: comparables and discounted cash flow analysis Global Equity 20

Pricing and Fees The Issuer The Business n Telecoms n Dot-Coms n Avons (How much volatility? ) Copyright © 2002 Ian H. Giddy Fees Pricing Debt 0. 15% to 1. 5% T+Spread L+Spread Equity 5% to 7% Comparables/Ratios The market Future cash flow valuation Global Equity 21

Relative Valuation l Do valuation ratios make sense? • Price/Earnings (P/E) ratios q and variants (EBIT multiples, EBITDA multiples, Cash Flow multiples) • Price/Book (P/BV) ratios q and variants (Tobin's Q) • Price/Sales ratios l It depends on how they are used -- and what’s behind them! Copyright © 2002 Ian H. Giddy Global Equity 22

Valuing a Firm with DCF: An Illustration Historical financial results Adjust for nonrecurring aspects Gauge future growth Projected sales and operating profits Adjust for noncash items Projected free cash flows to the firm (FCFF) Year 1 FCFF Year 2 FCFF Year 3 FCFF Year 4 FCFF Discount to present using weighted average cost of capital (WACC) Present value of free cash flows Copyright © 2002 Ian H. Giddy + cash, securities & excess assets - Market value of debt … Terminal year FCFF Stable growth model or P/E comparable Value of shareholders equity Global Equity 23

Dividend Discount Models: General Model l V 0 = Value of Stock l Dt

Constant Growth Model lg = constant perpetual growth rate Copyright © 2002 Ian H.

Constant Growth Model: Example n n Motel 6 has earnings of $5 per share. It reinvests 40% and pays out 60%dividend The required return that shareholders expect is 15% The earnings are expected to grow at 8% per annum What’s an M 6 share worth? E 1 = $5. 00 b = 40% k = 15% (1 -b) = 60% D 1 = $3. 00 g = 8% V 0 = 3. 00 / (. 15 -. 08) = $42. 86 Plowback rate Copyright © 2002 Ian H. Giddy Global Equity 26

Shifting Growth Rate Model l g 1 = first growth rate l g 2

The Investors’ Viewpoint: Equity Risk and Return 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? l Copyright © 2002 Ian H. Giddy Global Equity 28

The Weighted Average Cost of Capital Choice Cost 1. Equity - Retained earnings - New stock issues - Warrants Cost of equity - depends upon riskiness of the stock - will be affected by level of interest rates Cost of equity = riskless rate + beta * risk premium 2. Debt - Bank borrowing - Bond issues Cost of debt - depends upon default risk of the firm - 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 = Capital Cost of capital = Weighted average of cost of equity and cost of debt; weights based upon market value. Cost of capital = kd [D/(D+E)] + ke [E/(D+E)] Copyright © 2002 Ian H. Giddy Global Equity 29

International Equity Markets and Portfolio Diversification l l l No well-accepted international version of the capital asset pricing model. The benefits of diversification globally are empirical issues. The empirical case for international diversification has two components. 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? u l Then what we have to do is make sure we understand how international diversification is best achieved. Copyright © 2002 Ian H. Giddy Global Equity 30

International Diversification Pays More TOTAL RISK P o r t f o l i o DIVERSIFIABLE RISK R i s k NONDIVERSIFIABLE RISK skp 1 Copyright © 2002 Ian H. Giddy 5 10 15 20 Number of Securities (Assets) in Portfolio 25 Global Equity 31

The Global Efficient Frontier Copyright © 2002 Ian H. Giddy Global Equity 32

Raising and Pricing Equity Prof. Ian Giddy New York University

Raising Equity: The Investment Banker’s Job Market conditions l Corporate needs l Valuation l

Deutsche Telekom: The Sequence l See case Exhibit 2 Copyright © 2002 Ian H.

What’s a Company Worth to Investors? Required Returns l Types of Models l u. Balance Teleko m sheet models u. Dividend discount & corporate cash flow models u. Price/Earnings ratios u. Option models l Estimating Growth Rates Copyright © 2002 Ian H. Giddy Global Equity 36

Equity Valuation: From the Balance Sheet Value of Assets n Book n Liquidation n

Deutsche Telekom: Book Value l See case Exhibit 3 Copyright © 2002 Ian H.

Relative Valuation l Do valuation ratios make sense? • Price/Earnings (P/E) ratios q and variants (EBIT multiples, EBITDA multiples, Cash Flow multiples) • Price/Book (P/BV) ratios q and variants (Tobin's Q) • Price/Sales ratios l It depends on how they are used -- and what’s behind them! Copyright © 2002 Ian H. Giddy Global Equity 39

Deutsche Telekom: Ratios and Comparables l See case page 9 Copyright © 2002 Ian

Discounted Cashflow Valuation: Basis for Approach uwhere n = Life of the asset u CFt = Cashflow in period t u r = Discount rate reflecting the riskiness of the estimated cashflows u Copyright © 2002 Ian H. Giddy Global Equity 41

Deutsche Telekom: Earnings l See case page 8 Copyright © 2002 Ian H. Giddy

Valuing a Firm with DCF: An Illustration Historical financial results Adjust for nonrecurring aspects Gauge future growth Projected sales and operating profits Adjust for noncash items Projected free cash flows to the firm (FCFF) Year 1 FCFF Year 2 FCFF Year 3 FCFF Year 4 FCFF Discount to present using weighted average cost of capital (WACC) Present value of free cash flows Copyright © 2002 Ian H. Giddy + cash, securities & excess assets - Market value of debt … Terminal year FCFF Stable growth model or P/E comparable Value of shareholders equity Global Equity 43

What’s a Company Worth? Alternative Models l The options approach u. Option to expand u. Option to abandon l Lycos Creation of key resources that another company would pay for u. Patents or trademarks u. Teams of employees Messageclick. co u. Customers l Examples? Copyright © 2002 Ian H. Giddy m Global Equity 44