Topic 4: Financing I: Debt and Equity Capital Marks Flashcards
What are the pros and cons of issuing equity?
Pros: Can strengthen balance sheet, and will not lead to a deterioration in credit ratings (leading to lowest debt financing cots and potentially high long-term value
Cons: Equity offering generally has a higher cost of capital than a debt financing and will likely cause a drop in EPS for the issue (negative impact on share price)
What are the pros and cons of debt?
Pros: Lower cost of capital compared to equity
Cons: May weaken the company’s balance sheet and reduce financial flexibility-
- Therefore before issuing debt: need to assess cash flow to determine if interest charges can be covered by cash flow
What is an underwriting? What are the two types of underwritings?
Where the IB will buy securiities from an issue (at a discount) and then resell those securities.
Two types (determine by underwriting agreement)
- Best effort basis: Where the issuer bears the price risk
- Bought deal: bank bears security price risk
How are underwriters compensated?
Compensated by the gross spread: difference between the purchase and sale price - compensation for distribution effort and certain legal risk.
Who are the three types of participants in underwriting syndicates?
Lead bookrunner: Highest compensation - is responsible for the marking and pricing method of the transaction: highest underwriting allocation and most % of gross spread
Co-manager: Smaller underwriting allocations - therefore receive even lower compensations
Selling groups: no financial risk and the lowest compensations
What do underwriting league tables represent/ provide?
Basis for comparing banks underwriting capabilities
What are the three types of bond underwritings?
Best efforts: majority of transactions: issuer bears price risk and therefore least expensive. Underwriter will ‘explore the appropriate price for a security based on input from prospective investors’
Bought deal: IB buys the bond at a certain rate, common in competitive markets
Backstop commitments: Rate is ‘backstopped’ or committed to, however issue will get the lowest rate if it clears the market
What is an UPO?
What are follow on offerings?
What are secondary offerings?
IPO: When a company sells stock to the public for the first time in an ASIC registered offering
Follow on offering: Subsequent sales of stock to the public by the company
Secondary offerings: Where shareholders can sell shares using the company’s registration statement - with proceeds received by the shareholder and not the company
What are the three types of equity underwritings?
Fully marketed: issuer bears share price risk, 3-5 day management roadshow, red herring prospectus delivered, access to widest pool of investor demand
Accelerated: Issue bears smaller share price risk, 1 to 2 day management roadshow, red herring process delivered,narrow access to investor demand
Block trade: Investment bank bears share price risk, purchase commitment before the market opens the next morning, no red herring prospectus, eliminates market risk for issue, requires discount to market price to accommodate risk taken by the bank
What are the four pros and four cons of an IPO?
Pros:
1. Access to public market funding
2. Enhanced profile and marketing benefits
3. Creation of an acquisition currency & compensation vehicles
4. Liquidity for shareholders
Cons:
1. ASIC reporting requirements
2. Costs associated with on-going reporting
3. Disclosure of sensitive information
4. Short term focus by management to meet investor expectations in quarterly reports
How do IBs typically price an IPO?
They will use valuation methodologies (including DCF), and will often set the IPO price at a discount to the determined price to encourage investor interest
What is the difference between an IPO and follow on offering?
Following on offering: DOES NOT include a price range since the shares are priced in relation to the market price of the issuer’s shares on the exchange they are listed
What are the effects of a secondary offering? What impact does this have on EPS?
New shares cause a dilution to current shareholders in terms of EPS: unusual for proceeds to be in excess of 25%
What is a greenshoe option? What does it do?
Allows the investment bank to sell short securities equal to 15% of the securities sold in an IPO
- Mitigates downside share price risk
Who will IB buy 15% of shares from which share price increases?
The company > this will mean 115% of shares will be issued
