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FCNE20005 - CFDM > Lecture 2: Raising Capital - Equity > Flashcards

Lecture 2: Raising Capital - Equity Flashcards

1.) Equity: Characteristics 2.) Floating Process 3.) Short-run and long-run performance of IPOs 4.) SEO - Rights issues vs Placements 5.) Process of Underwriting

1
Q

What are the 5 rights of Shareholders

A
  1. ) An ordinary share gives the shareholder ownership of equity in the company
  2. ) Shareholders are allowed to vote on matters such as election of board of directors
  3. ) Shareholders are allowed to sell their shares
  4. ) Shareholders are entitled to a PROPORTIONAL share of dividends
    5) Shareholders have a SUBORDINATED right to return of their capital upon liquidation of the company
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2
Q

What is subordinated right of shareholders?

A

It means that debt holders are paid first before shareholders

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3
Q

What is an IPO

A

Initial Public Offering

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4
Q

What are the 3 steps of Floating

A
  1. ) Engage an Investment Banker/Underwriter
  2. ) Conduct a roadshow
  3. ) Set the price and list
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5
Q

What does an Investment Banker do?

A
  1. ) Prepare the prospectus

2. ) Underwrite Service (Maybe)

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6
Q

What is a prospectus?

A

Legal document detailing the IPO.

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7
Q

What does the underwriter do?

A

For a fee, it guarantees that all issued shares will be sold. He is liable to purchase any unsold shares

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8
Q

Why and How does an underwriter provide the service?

A

Why: They USUALLY have a clear incentive to have shares sold
How: It conducts a marketing roadshow

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9
Q

What are the 2 main methods of deciding the subscription pricing of an IPO

A
  1. ) Fixed Pricing

2. ) Bookbuilding

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10
Q

What is fixed pricing

A

Price is set, prospectus is sent out and offers are received

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11
Q

What are the 2 kinds of bookbuilding

A

Competitive bidding by INSTITUTIONAL INVESTORS (NOTE)

  1. ) Open Pricing: Bids are taken the final price which clears the market
  2. ) Constrained Open Pricing: Indicative range and bids within the range are provided
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12
Q

What are key differences between fixed pricing and bookbuilding

A
  1. ) Price: Fixed = known to investors; Bookbuilding = Not known to investors
  2. ) Demand: Fixed = known only after issue closes; Bookbuilding = known daily as book is built
  3. ) Investors: Fixed = no discretion over investor quality; Bookbuilding = can decide the investors
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13
Q

What if the subscription price is too high or too low

A

Too high = No one will buy the shares.

Too low = Owners of firm will suffer opportunity cost in which shares could’ve been sold higher.

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14
Q

What price are the shares that are initially issued by the issuing firm

A

Subscription prices. This is the primary market

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15
Q

What is the market for trading in the market and when does it take place for an IPO

A

Secondary market - within share holders and buyers in the stock exchange

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16
Q

Formula for underpricing

A

Underpricing = (Closing price first day of trading - Subscription Price)/ Subscription Price

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17
Q

Define underpricing

A

Underprice is defined when the subscription price is below the “true” value of the firm

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18
Q

What are the 7 Reasons for Underpricing (Acronym)

A

II LL MBS

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19
Q

Reason for Underpricing and Explanation (1st I)

A

Information Asymmetry & Winner’s Curse

Underpricing will keep uninformed investors in the market.
Overprice - All shares go to uninformed
Underprice - Majority go to informed

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20
Q

Reason for Underpricing and Explanation (2nd I)

A

IPO Spinning

Investment bankers have ulterior motives

  1. ) Lower the cost of underwriting
  2. ) Maintain good relationship with other potential clients
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21
Q

Reason for Underpricing and Explanation (1st L)

A

Liquidity

Encourage more investors > dispersed ownership > More secure management and liquidity in secondary market

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22
Q

Reason for Underpricing and Explanation (2nd L)

A

Lawsuit Avoidance

Underpricing is a form of expensvie insurance. Reduce the severity of lawsuit (esp. in cases where people don’t read prospectus, lose money, and file a suit)

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23
Q

Reason for Underpricing and Explanation (M)

A

Market Feedback

Issuer uncertain of firm’s true value. Initial bookbuilding process allows issues to find out from the market its’ firm’s true value

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24
Q

Reason for Underpricing and Explanation (B)

A

Bandwagon/Cascade

Investors are more likely to subscribe to floats perceived as popular. Induce first wave of popularity

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25
Q

Reason for Underpricing and Explanation (S)

A

Signalling

Leave good taste with investors for future expansion such as SEO

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26
Q

Reasons for Long-Run Under performance of IPOs (Acronym)

A

DIW

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27
Q

Reasons for Long-Run Under performance of IPOs (D)

A

Divergence of Opinion

IPO = Optimistic investors
Information available over time > Less divergence of opinion between optimistic and pessimistic investors

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28
Q

Reasons for Long-Run Under performance of IPOs (I)

A

Impresario

Initially hype/marketting by investment bankers died down.

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29
Q

Reasons for Long-Run Under performance of IPOs (W)

A

Windows of Opportunity

Decline in demand for IPOs correlated with a market-wide reduction in equity values. Hence, relative to the entire market

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30
Q

How to be successful in IPO (General)

A

Careful analysis in Prospectus and Valuation

31
Q

3 Factors to be successful in IPOs

A
  1. ) Gauge market mood and demand for each offering
  2. ) More shares in underpriced firms (Allotment game)
  3. ) Remember transaction costs and winners curse
32
Q

What are the advantages of Book-building compared to Fixed Price Offer

A

1.) Information provided by informed (institutional) investors sets the issue price > Risk of undersubscription virtually eliminated + issue price likely to be higher than fixed fees

33
Q

What are the disadvantages of Book-building compared to Fixed Price Offer

A
  1. ) Book-building involves significant costs (hence viable only for large issues)
  2. ) Possible investment banking conflicts - investment bankers may allocate hot IPO shares to their favoured clients.
34
Q

“The interest held by ordinary shareholders is a residual claim.” Explain the meaning

A

Ordinary shareholders are paid last - Entitled to the profit (if any) that remains after all other claimants such as suppliers, employees, lenders and government bodies have been paid

35
Q

“The interest held by ordinary shareholders is a residual claim.” Explain the significance

A

Ordinary shareholders are exposed to greater risk than all other claimants.

36
Q

Seasoned Equity Offerings - What are the different types and to whom

A
  1. ) General Offers: Public
  2. ) Rights Issue: Existing shareholders
  3. ) Private Placement: Financial Instiutions
  4. ) Dividend Reinvestment Plan: Existing shareholders
37
Q

Seasoned Equity Offerings - How do we decide which to choose (4 Factors)

A
  1. ) Time to implement
  2. ) Cost of implementation
  3. ) Potential transfer of wealth from old to new shareholders
  4. ) Regulation (Law)
38
Q

What are Rights Issues?

A

An offer of new shares to existing shareholders in a fixed proportion to the number of shares already held

39
Q

What is the typical price of Rights Issues?

A

The subscription price is often at a 10-30% discount

40
Q

What are the disadvantages of Rights Issues

A

Timely. ASX Listing Rules Appendix 7A prescribes a minimum 18 business day timetable from announcement to issue of shares

41
Q

What is cum-rights and ex-rights

A

Cum-Rights: Market trades with the rights.

Ex-Rights: Market trades after rights has been issued (i.e. without the rights)

42
Q

What is the formula for valuating the price of shares ex-right

A

X = (NM + S) / (N+1)

N = 1 for N
M = Current price
S = Subscription Price
43
Q

What is the formula for valuating the price of right (If you have the ex-rights price)

A

R = X - S

R = Ex-rights price - Subscription Price

44
Q

What is the formula for valuating the price of right (if you do not have the ex-rights price)

A

R = N (M - S) / (N + 1)

N = 1 for N
M = Ex-rights price
S = Subscription Price
45
Q

What is the key property of Rights, its 3 states and its consequences

A

Renouncable

  1. ) Exercise rights and obtain shares
  2. ) Sell rights and obtain cash ( - Ownership)
  3. ) Let rights lapse (- Ownership - Wealth)
46
Q

Do share prices drop on announcement date of rights?

A

Typically, yes. This is because of information asymmetry. Managers believes share are overvalued and investors pull out because they are scared.

47
Q

Who is allowed to receive private placements

A

Financial Institutions. Limited no. of investors

48
Q

Are placements discounted?

A

Not all. Some are at a premium.

49
Q

What are the advantages of placements over rights

A
  1. ) Lower transaction cost

2. ) Fast

50
Q

What are the disadvantages of placements over rights

A
  1. ) Dilution of value
  2. ) Dilution of ownership
  3. ) Regulatory Legal Constaints
51
Q

What is the legal constraint of placements

A

ASX Listing Rule 7.1:

Companies with market cap >$300mil from issuing more than 15% of their issued capital via a private placement within a given 12 month period without first obtaining the approval of its shareholders

52
Q

Why is there a need for legal constraints

A

Substantial loss in wealth if management placed a large block of shares to a small group of new investors at a substantial discount to the current share price.

53
Q

What are Dividend Reinvestment Plans (DRP)

A

Offer shareholders the option of using all or part of their dividend to purchase additional shares (usually at a small discount) without incurring brokerage fees

54
Q

What are the advantage of DRP

A

Allow high dividend payouts while reducing cash outflows

55
Q

Capital Raising in Australia in general: Legal Consideration and what is a key document

A

The Corporations Act 2001: Must have prospectus detailing all information about the IPO

56
Q

What is the intuitive function of underwriting

A

It is a put option by the company and a form of insurance.

Think: Don’t sell > Shares drop > Payoff increase

57
Q

Why is underwriting used less today

A

80% > 30% due to success of book-building

Subscription price is low, one would expect that most shareholders will exercise their
option to buy the new shares.

58
Q

What is the risk of not underwriting

A

If the price of shares drops, the
incentive for investors to buy the new shares decreases. Company may not be able to sell all its
shares to raise all the capital it needs.

59
Q

What is the point of a roadshow

A
  1. ) Market the float

2. ) Gauge the interest of investors

60
Q

Do different countries have different levels of underpricing. When?

A

Yes. The less transparent the laws of the country are, the more underpricing there tend to be

61
Q

What is the average underpricing from 1970 - 2016

62
Q

Historically, what kind of companies have more underpricing

A

Small companies generally have more underpricing than large companies

63
Q

What kind of effects is akin to Dividend Reinvestment

A

It’s like a small rights issue

64
Q

What are accelerated rights

A

2-Step Process

  1. ) Shares offered on a pro-rata basis to institutional shareholders
  2. ) Shares are then offered on a pro-rata basis to retail investors at the same price that has been offered to institutional shareholders
65
Q

What is the advantage of accelerated rights

A

Allow funds to be raised more quickly than under a traditional rights issue, whilst still allowing retail investors to participate (vs private placement)

66
Q

What are some reasons a firm might want to go public

A
  1. ) Public companies have better access to the capital market
  2. ) Owners can cash in on their business > use them to diversify their investment portfolio
67
Q

What are some costs/negative outcome a firm might go through to go public

A
  1. ) Loss of ownership for original owners (Since they have to share ownership with other investors)
  2. ) Direct costs of listing
  3. ) Cost associated with greater information disclosure (plans must take into account stock prices and stuff)
68
Q

What are some costs of floating (Money)

A
  1. ) Fees for listing : Legal fees, preparing prospectus, printing
  2. ) Fees for underwriting/commission: 1-5%
  3. ) Underpricing
69
Q

Are all IPOs good investments

A

No. About 28% has negative returns.

70
Q

What are the statistics regarding long-run under-performance of IPOs

A

They perform worse than the market (firms that have not just gone listed)

71
Q

What is the main role of underwriting

A

Guarantee the success of the issue

72
Q

What basis may underwriting be on

A

“Fixed” or “Best Efforts” Basis

73
Q

What else do underwriters do other than guarantee the success of issuing

A

They assist with the distribution and management of the offer

74
Q

Do all underwriters have sub-underwriters?

A

Not all, but typically they are contracted to take up a fixed proportion of any undersubscription

FCNE20005 - CFDM (15 decks)

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