Ross Template

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15
Chapter
Investment Banking Public and Private
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Chapter 15 - Outline

• What is Investment Banking?
• Functions of the Investment Banker
• Underwriting Spread
• Public vs. Private Companies
• Advantages and Disadvantages of a Public Company
• Initial Public Offering and Leveraged Buyout

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What is Investment Banking?

• Investment Banking deals with primary offerings
  of new securities
• The Investment Banker serves as the intermediary
  or link between the corporation and the investor
• Brings the two parties together by channeling
  money from one to the other

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The Role of Investment Banking
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The Investment Banker is a link between the
corporation in need of funds and the investor.
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The Investment Banker is responsible for
designing and packaging a security offering and
selling the securities to the public
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Competition in the Investment Banking industry is
very intense.
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Raising capital has become an international
propositionfirms need to be very large to
compete.
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Table 15-1, Page 425, lists the top investment
bankers in 2000.
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The list has its share of foreign investment
bankers.
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Many investment banks specialize in specific
types of securities.
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Functions of the Investment Banker
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Underwriter

• buying the security and reselling it to the
  public
• the risk-taking function
• Large firms normally assume risk of distribution.
• Small firms may work on a best efforts or
  commission basis.

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Market Maker

• ensuring an available market by buying and
  selling the security

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Advisor

• providing advice on the issue

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Agent

• Helping make a private placement with an
  insurance ocmpany, wealthy individual, or pension
  fund

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The Distribution ProcessSome Terms
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Managing investment banker

• The principalcalls on other investment banking
  houses to share the burden of risk and to aid in
  distribution.

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Underwriting syndicate

• Act as wholesalers in distributing shares to
  brokers and dealers.

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Brokers and dealers

• Eventually sell shares to the public.

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Figure 15-1 (next) shows the distribution process.
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Figure 15-1Distribution process in investment
bankingPage 428
T 15-1
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Underwriting Spread

• Spread represents the compensation for those
  participating in the distribution
• Spread Public Price - Issue Price
• It is shared by all the participants
• Spread on common stocks is greater than spread on
  bonds

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Distribution Spread
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Table 15-2 shows SEC figures concerning spreads.
Note that whether the new issue is debt or common
stock, the spread declines as a percentage of the
size of the issue, as the size of the issue
increases.
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Figure 15-2Allocation of Underwriting
SpreadPage 429
T 15-2
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In Figure 15-2, The managing banker pays the firm
20 and the public ultimately pays 21.50, making
the spread 1.50. The spread is actually
distributed as follows
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To the managing investment banker

• 1.50 if sold to the public
• .75 if sold to dealers

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To other syndicate members

• 1.25 if sold to the public
• .50 if sold to other dealers

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To selected dealer group

• .50 if sold through brokers
• .75 if sold to the public

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Brokers--.25 when sold to public
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Table 15-3 (no slide) shows that when the spread
plus out-of-pocket costs are considered, the
total cost of a new issue is rather high,
depending on the size of the issue.
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Out-of-pocket costs include such items as legal
and accounting fees, printing expenses, etc.
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Because the costs are high, it is desirable to
get as large a new issue as possible for most
companies that go to market.
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Pricing the Security
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Primary offering

• Shares are sold to the public for the first time.

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Secondary offering

• A large block of already trading securities is
  sold at below current prices to the public.

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Underpricing

• When a company whose stock is already trading
  issues additional shares, the investment banker
  will generally set the price at slightly below
  the current market value.

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The investment banker must perform a market
analysis and carefully price the stock, since
they will ultimately be responsible for selling
the issue to the public and bear the risk that
the stock does not sell.
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Dilution

• Suppose Maxwell Company currently has 2,500,000
  shares outstanding and earnings of 5 million.
• Then, EPS before any new issue will be 2 per
  share.
• If Maxwell issues 250,000 new shares, its EPS
  will temporarily drop to about 1.82 per share.
• The market anticipates this dilution, and when a
  company announces that it will sell new shares,
  its stock price often drops.

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Market Stabilization

• The managing investment banker is generally
  responsible for stabilizing the offering during
  the distribution period and may accomplish this
  by repurchasing securities if the market price
  moves below the initial public offering price.

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Aftermarket

• Studies provide evidence that initial public
  offerings often do well following the public
  issue.
• Because managing underwriters may underprice the
  issue initially to ensure a successful offering,
  often the value jumps after the issue first goes
  public.

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Changes in the Investment Banking Industry

• Investment banking is becoming nationally
  oriented
• There have recently been mergers between large
  commercial banks and brokerage/investment banking
  firms.
• Market share and concentration of power has
  increased, with the top ten investment banking
  firms controlling over 65 percent of the
  worldwide underwriting market.
• The top 4 investment banking firms control 40 of
  the market.

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Shelf Registration

• Under SEC Rule 415, Shelf registration permits
  large companies, such as Exxon or Citigroup, to
  file one comprehensive registration statement
  that outlines the firms financing plans for up
  to the next two-and-one-half years.
• This allows the company to get to the market
  quickly when conditions are right, without SEC
  approval.
• Future issues are sitting on the shelf.

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Public vs. Private Companies

• Public company
• when shares of a company are offered to the
  public
• anyone can buy shares of the stock
• Private company
• privately owned or held by an individual or
  family
• not available to the general public

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Advantages and Disadvantages of a Public Company

• Advantages of being public
• greater availability of funds (easier to grow and
  raise money)
• prestige
• Disadvantages of being public
• company information must be made available to the
  public (opening the company up to public scrutiny
  and criticism)
• high costs of going public (expensive)

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Public Offerings
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Your text has examples of two public offerings,
EDS (Page 434) and Internet Capital Group (Page
435).

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Figure 15-3, page 437, is the tombstone
advertisement for the Internet Capital Group
offering and depicts many of the characteristics
of the distribution process.

• Lead underwriter is Merrill Lynch Co.
• Offering is co-managed by Goldman, Sachs Co.
• Syndicate members are listed by size of their
  position
• Number of shares to be sold are shown, as is the
  offering price

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PPT 15-3
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Initial Public Offering and Leveraged Buyout
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Initial Public Offering (IPO)

• when a company sells its stock to the public for
  the first time
• company becomes publicly traded

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Leveraged Buyout (LBO)

• money is borrowed to repurchase all the shares of
  the company resulting in a great deal of debt
• when a company goes private

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Privitization

• A previously government-owned company is sold to
  and becomes owned by the private sector.

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THE END