INVESTMENT BANKING LESSON 3 INITIAL PUBLIC OFFERINGS IPOs

INVESTMENT BANKING LESSON 3: INITIAL PUBLIC OFFERINGS (IPO’s): How Investment Bankers Sell Companies Investment Banking (2 nd edition) Beijing Language and Culture University Press, 2013 Investment Banking for Dummies, Matthew Krantz, Robert R. Johnson, Wiley & Sons, 2014

LESSON 2 REVIEW 1. WHAT WERE SOME OF THE CAUSES OR REASONS FOR BANK PANICS, DEPRESSIONS AND RECESSIONS? 2. WHAT IS ONE PIECE OF LEGISLATION (LAW) OR A REGULATION THAT AFFECTED IB? 3. WHAT DO YOU THINK ARE SOME OF THE ISSUES THAT WILL AFFECT OR CHANGE THE FINANCIAL INDUSTRY IN THE FUTURE? 4. WHY DO COMPANIES WANT TO BUY OTHER COMPANIES?

LESSON 2 REVIEW 5. WHAT IS AN LBO? WHAT ARE THE PROs and CONs? 6. WHAT IS THE TYPE OF IB THAT MOST OFTEN DO LBO’s? AND HOW DO THEY DO IT? 7. WHAT ARE THE STAGES OR STEPS AN ENTREPRENEUR MIGHT TAKE TO GROW HIS/HER CO. 8. WHAT ARE THE ROLES OF SELL-SIDE AND BUY-SIDE ANALYSTS?

LESSON 3 TOPICS FOR TODAY 1. IPO’S (INITIAL PUBLIC OFFERING) INTRODUCTION 2. WHAT MAKES AN IPO HAPPEN? 3. WRITING THE PROSPECTUS 4. SUPPORTING THE IPO 5. THE ROLE OF THE SELL-SIDE ANALYST 6. THE GOALS OF THE SELL-SIDE ANALYST 7. EXAMINING A RESEARCH REPORT

LESSON 3 INITIAL PUBLIC OFFERINGS (IPO’s): 1. INTRODUCTION OK, now that you’ve got a good understanding of investment banking, do you want to be an IB? Much of what investment bankers do pays them lots of money, but the work is behind the scenes in the back rooms of the financial system. But, if there is one area where investment banks really shine it is in the process of selling a company to the public for the first time – the IPO. We’re going to spend this lesson learning about it!

LESSON 3 IPO’s Introduction (cont) One of the key jobs of an IB in bringing a company to the public is creating a document that spells out the details of the offering. This is called the prospectus. And it is the sell-side analysts that help complete the IPO process. An IPO requires a willing company that’s looking to raise money by selling part of itself to investors. As a review, so why do companies go public and turn to IPO’s?

LESSON 3 IPO’s Introduction (cont) Bank loans are too expensive – requires interest payments Venture capitalists want too much of the company and then cash out for huge profits. Bonds are too expensive as investors want high rates.

LESSON 3 2. WHAT MAKES AN IPO HAPPEN? A. THE COMPANY MUST BE IN AN INDUSTRY THAT INVESTORS ARE INTERESTED IN B. THE COMPANY MUST BE IN A FAST GROWTH PACE IN IT’S LIFECYCLE C. THE COMPANY MUST HAVE A STRONG COMPETITIVE ADVANTAGE Let’s look at these!

LESSON 3 WHAT MAKES AN IPO HAPPEN? (cont) A. THE COMPANY MUST BE AN INDUSTRY THAT INVESTORS ARE INTERESTED IN REAL WORLD EXAMPLE: Think internet. In the 1990’s and early 2000’s any company with an e before it’s name or a dot. com after it was able to sell stock and get a huge valuation. Year # of IPO’s # internet IPO’s % 1998 322 40 12. 4% 1999 504 272 54. 0% 2000 397 149 37. 5%

LESSON 3 WHAT MAKES AN IPO HAPPEN? (cont) B. A FAST GROWTH PACE IN IT’S LIFECYCLE - Investors look at the growth rate to see how it compares with other companies. Alibaba's IPO now ranks as the world's biggest at $25 billion, giving underwriters of the sale more than $300 million. That means the IPO has surpassed a previous global record set by Agricultural Bank of China Ltd in 2010, when the lender raised $22. 1 billion. According to its prospectus, Alibaba had agreed to sell 26. 1 million additional shares under the option. Citigroup Inc, Credit Suisse Group AG, Deutsche Bank, Goldman Sachs Group Inc, JPMorgan Chase & Co and Morgan Stanley acted as joint bookrunners of the IPO.

LESSON 3 WHAT MAKES AN IPO HAPPEN? (cont)

LESSON 3 WHAT MAKES AN IPO HAPPEN? (cont) C. STRONG COMPETITIVE ADVANTAGE – If investors are going to take a risk they want a company that has little competition and high barriers to entry, meaning it would be costly for a competitor to take on the company. REAL WORLD EXAMPLE: Visa card and UPS (a shipping company) were the number 1 and 11 largest US IPO’s ever but both were large companies and had few competitors.

LESSON 3 3. WRITING THE PROSPECTUS The most important document the company the investment bankers must produce is the prospectus. The following 14 points outline the document which is quite detailed. Just a brief description for each point. A. SUMMARY: Gives the companies plans, like how many shares they plan to sell and what price why the company is looking to sell stock. B. RISK FACTORS: The Co. and IB warn investors of all the possible things that could go wrong. C. INDUSTRY DATA AND METRICS: What is the industry like that the company is. Food, Utilities, Energy, etc

LESSON 3 WRITING THE PROSPECTUS (cont) D. USE OF PROCEEDS: What is the money being used for, the purpose of the company. Is it to pay off debt or big salaries for managers-problem? E. CAPITALIZATION: Will the financing be done with say, preferred stock or common stock? F. FINANCIAL DATA: Financial statements like income statement, balance sheet, cash flow statement, etc. G. MANAGEMENTS DISCUSSION & ANALYSIS OF FINANCIAL CONDITION H. BUSINESS: The Co. explains it’s products and services. I. MANAGEMENT: The company is only as good as it’s management. Listing of all the key managers, like CEO, COO, CFO, etc. J. EXECUTIVE PAY: How much do the “top dogs” get paid and bonuses, etc

LESSON 3 WRITING THE PROSPECTUS (cont) K. RELATED-PARTY TRANSACTIONS: What other relationships are part of the deal? L. PRINCIPAL & SELLING SHAREHOLDERS: If a public company who are the people selling the shares and a private company, who are the big investors. M. UNDERWRITING: List of all the advisors who made this IPO happen. N. LEGAL MATTERS: Are there any lawsuits or legal matters against this company. As you can see this is a very detailed, complete document that covers EVERTYTHING!!!

LESSON 3 4. SUPPORTING THE IPO When IPO’s fail, IB’s look bad. If shares of an IPO cannot stay above the offering price (price that shares are sold to first investors) it’s bad for the bank. If shares were priced too high, investors paid too much. If the shares go below the price of the IPO in aftermarket trading, it’s called a broken deal.

LESSON 3 SUPPORTING THE IPO (cont) AFTER THE IPO Lockup period – This is a set period of time when the officers and directors of the company cannot sell their shares. This would create a massive selling off and the first investors would lose. Again, not good for IB’s. usually this time is 90 days. A second group can sell after 180 days and a third group 365 days. This way IB’s can control the flow of stock into the market

LESSON 3 SUPPORTING THE IPO (cont) BEFORE THE IPO Quiet periods – Regulators and investors want to control the information that gets out before the IPO. A company cannot promote activity to push up the price before the IPO. This can be a little difficult since part of the IPO process includes the roadshows, which are visits with potential investors.

LESSON 3 5. THE ROLE OF THE SELLSIDE ANALYST The one thing nobody wants to have happen is for the IPO to break, or fall below the offering point. So IB’s offer aftermarket research support. As we saw in the lesson, the sell-side analysts provide research to keep investors informed on what the stock is worth. Their job is to use fundamental analysis to determine the value of a company. What are the goals of the sell-side analyst?

LESSON 3 6. THE GOALS OF THE SELL-SIDE ANALYST 1. PROTECTING NEW STOCKS FROM BEING LOST AND FORGOTTEN – When a company goes public, it’s now in competition with 1000’s of other stocks investors can buy. By providing informed analysis, the sell-side analyst keeps attention on the new public company. 2. PROVIDING FUEL (INFORMATION) FOR THE BUYSIDE ANALYSTS who are always looking out for great companies to help them “beat the market” to justify the fees they charge investors.

LESSON 3 THE GOALS OF THE SELLSIDE ANALYST (cont) 3. BY PROVIDING RESEARCH REPORTS, INSTANT UPDATES AND INDUSTRY ANALYSIS, the sell-side analysts help investors to know what to look for when investing.

LESSON 3 7. EXAMINING A RESEARCH REPORT There is no standard for research reports but they will include some of the following items: 1. RECOMMENDATIONS: This tells investors what the analysts think about buying the investment. They use terms such as, “strong buy”, “hold”, “sell”, or “strong sell”. TIP: Many beginning investors tend to follows the recommendation but it’s best just not to blindly follow the recommendation.

LESSON 3 EXAMINING A RESEARCH REPORT (cont) 2. PRICE TARGET: According to analysts this is where they think the stock could be trading in 1 year. 3. KEY STATISTICS: Gives investors a summary of data like the stock price and ratios such as EPS (earnings per share) and P/E (price-to-earnings). This area of the report has a forecast of the company’s future earnings, key to knowing a price target.

LESSON 3 EXAMINING A RESEARCH REPORT (cont) 4. HIGHLIGHTS/SUMMARY: Contains a lot of information about the industry. 5. INVESTMENT OPINION: This area gives the reason behind the analyst’s recommendation. 6. BUSINESS SUMMARY: This is a summary of the type of business the company is in and what are the key drivers of the company. What does the business do in detail.

LESSON 3 EXAMINING A RESEARCH REPORT (cont) 7. RATIO ANALYSIS AND FINANCIALS: The best way investors can find out about a company is by using ratio analysis. There are many ratios that will help investors assess the true value of the company. We will learn about the ratios later in the course. 8. INDUSTRY OUTLOOK: This part explains the industry and how the company compares with other companies within the industry.

LESSON 3 COVERED IN YOUR TEXTBOOK CHAPTER 4 Pages 56 -80 Basically the whole chapter is good additional resource material paying attention to section 4. 2 Motivations of issuers 4. 3 The IPO Team 4. 4 The IPO Process 4. 5 Pricing of an IPO 4. 8 Costs of going Public 4. 9 Aftermarket Trading 4. 12 China’s Practices