Class 11 (IPO Pricing).pptx

Initial Public Offerings Corporate Finance & Banking FIN 666 Fall 2024  Investment Banks and Underwriting Investment banks act as an intermediary between issuers of securities and investors in securities The underwriting process and the publication of r...

Initial Public Offerings Corporate Finance & Banking FIN 666 Fall 2024  Investment Banks and Underwriting Investment banks act as an intermediary between issuers of securities and investors in securities The underwriting process and the publication of research helps to bridge the information gap between issuers and investors Investment banks help issuers manage risk by underwriting securities The bank typically commit to buy securities from the issuer at a predetermined price, prior to reselling the securities, at the same price, to investors  Equity Issuance - Terminology Initial Public Offerings (IPO) The first offering of a company’s shares to the public. A formerly private company becomes listed on a public exchange. Secondary Offerings A public offering of company shares after the IPO. Typically a large block is offered that has been held by large investors or institutions. Proceeds of the sale go to the selling shareholders, not the issuing company. The offering is not dilutive to existing shareholders since no new shares are created. Follow-on Offering Also known as a subsequent offering, this is the sale of new shares into the market. Proceeds go to the company. The offering is dilutive to existing shareholders.  Pros & Cons of IPO / Life as public company Pros Cons Raise capital and open a window for Expensive (at issuance) future fundraising Time consuming process Broaden the shareholder base Extensive disclosure Provide liquidity to insiders Ongoing administration & reporting Elevate the status and public burden awareness of a company Market will focus on recent and near Provide an acquisition currency term performance Provide an alternative and liquid form of compensation to employees  The right time for an IPO At some point, many successful firms go public. Most are backed by Venture Capital (VC) VC firms can partially exit via an IPO. Often, they try to time the market, to achieve an attractive IPO valuation When are firms ready? Traditional view (30 years ago): $50+ million in revenues (2024 $s) At least 2 quarters of profitability Modern view: Market will focus on “top-line” metrics Need a good story, selling a future vision IPO Market Volume IPO Volume (U.S. Market) Source: Stock Analysis Largest IPOs Largest IPOs IPO Process  IPO Process: Types of underwriting Underwriting agreement: The agreement between the investment bank and the issuing company that defines the terms, conditions and limitations under which the underwriter will work to promote and sell securities Firm commitment: The underwriter purchases the stock from the client and assumes the selling risk. If the deal is mispriced, there is potential for sizeable losses for the underwriting bank at the time of issuance Best efforts: The underwriter agrees to sell the shares, however there is not an obligation for the underwriter to buy the shares. It is rare for an underwriting to fail with the underwriter unable to place shares. More often, IPOs are “pulled” or delayed due to a change in overall market conditions. Banks have reputation risk.  IPO Process: Steps of IPO Origination process (from the I-banks perspective) Review of prospective issuer Comparison of equity offering & alternatives Evaluation of equity market conditions Pitch (recommendation and estimate of terms) Company selects lead bank Organize participants – lead managers, co-managers, legal counsels, etc. Due diligence Documentation and registration (S1) Market the offering (to potential investors) via road show Set the price Syndication and selling process - seek diversification & breadth  IPO Process: Setting the price Pricing an IPO requires skill & experience. Banker judgment is important Banks use valuation metrics to determine the appropriate pricing range: Trading comparables Transaction comparables DCF valuation The trading multiple is discounted by 15%. This is the “IPO discount” The IPO Multiple = Trading Multiple / (1 + IPO discount) Thus, IPOs are priced to appreciate by 15% Ultimately, pricing is based on the book building (from road show) and estimated market demand On the first day of trading, most firms trade above their IPO price. On average, the first day increase is 5 -15%  IPO First-Day Returns Source: Jay R. Ritter, IPO Statistics  IPO Process: Investment banking fees IPO fees are typically set at 7% of the underwriting amount (the gross proceeds). The 7% is called the “gross spread” The gross spread (7%) paid to underwriters is intended to cover management fees, selling commissions and underwriting concessions Very little competition between banks to modify this fee Only in mega sized IPOs will the fee percentage be reduced (4% or less) The company going public will incur additional costs (“offering expenses”) related to legal, accounting, filing fees and printing  IPO Process: Post offering stock price The post offering price will fluctuate based on a variety of factors: Research coverage and overall visibility Trading volume and liquidity Lock-up expiration and insider selling Hitting performance numbers. Meeting or exceeding expectations of “the Street” (research analysts)  1990s Tech Bubble The World’s Hottest IPO Market Ever! IPO First-Day Returns  Internet Bubble IPOs During the 1990s bubble (mid 1998 - 2000), technology and dot.com companies were experiencing meteoric rises on the first day “pop” First day returns for internet companies averaged 65% In many cases the price after opening rose by more than 200% The price appreciation and potential for huge immediate profits led to a form of kickbacks In some cases, I-banks began to allocate IPO shares to institutional and corporate executives in exchange for inflated commissions or future favors  A Week in the Internet Bubble Books-A-Million (Ticker BAMM) BAMM goes public in the mid 1990s. Company has 174 stores Ranks as No. 3 book retailer, after Barnes & Noble and Borders Went public at $13 in 1992 Recent financial results had been lackluster Stock trades near $5 (past 12 months) November 25, 1998 (Wednesday). 10:00 am BAMM announces that they are launching an improved website Same as the original with more color and better search capabilities BAMM page visits are not even in the top 8000 of Web sites Amazon and Barnes & Noble rank among top Web sites by user visits Nov. 25, 1998 9:57 am BAMM stock is up 38 cents at $5 per share 9:58 am BAMM media release “Books-A –Million Announces Enhanced Website” The release promises the best prices on the Internet 10:30 am Yahoo message board lights up. Stock moves higher. BAMM at $9.00 10:51 am Yahoo message board: “Damn, I love this stock” “Bought 1500 shares at $5.25 less than half an hour later sold all at $7.75 …BAMM will hit $100 by Christmas…Buy, Buy, Buy! 1:11 pm Equity Analyst from Robinson –Humphrey “There appears to be no fundamental reason for the strength of BAMM shares other than the modest enhancement of the already existing web site. However the web has not been nor is expected to be a meaningful part of BAMM business over next year. Downgrade from “Buy” to “Hold” BAMM trading at $11.50 2:00 pm Fund manager (Dean Investment Assoc.) “This thing should be an $8, $9, maybe a $10 stock.” Sells entire position. BAMM now at $12. Nov. 26, 1998 (Thanksgiving Day) 4:20 pm Yahoo Message board: “BAMM should certainly be higher based on their recent understanding of the new website enhancements. We’ll see !!” Nov. 27, 1998 9:23 am Yahoo message board: “I look for a run to $20 or $21 then a huge sell-off into the $9-$10 range. 9:42 am BAMM spikes to $19.25 (up another $6.31) 10:26 am CNBC mentions BAMM. Atlanta Day-trader Mr. Chadwick sees stock surging, buys 500 shares at $23.875. 10:39 am Chadwick sells out at $29.75. Makes $3,000 in 13 minutes 12:00 Noon Fund managers dumping shares. Insiders (CEO, CFO, etc.) are unloading (these trades won’t be known for a few days) 4:00 pm Closing price? (close)  1990s IPO Stars Price (Adj. for splits) % Gain First day Price Offer value thru Company Close 12/29/00 ($mil) Offer date 12/29/00 Underwriter Cisco Systems $0.08 $38.25 $50 02/16/90 49,017 MSDW AOL Time Warner 0.12 34.80 23 03/19/92 30,148 DBAB JDS Uniphase 0.26 41.69 16 11/17/93 16,044 Unterberg Harris Veritas Software 0.64 87.50 19 12/08/93 13,539 SG Cowen Qualcomm 1.13 82.19 64 12/13/91 7,206 Lehman Ascend Comm 1.88 110.03 26 05/12/94 5,769 MSDW Applied Micro 1.47 75.05 44 11/25/97 5,010 RS Network Appliance 1.28 64.19 34 11/21/95 4,910 Lehman BEA Systems 1.56 67.31 30 04/10/97 4,208 Goldman Xilinx 1.17 46.13 25 06/12/90 3,855 MSDW PMC Sierra 2.03 78.63 32 04/24/91 3,771 MSDW Siebel Systems 1.92 67.63 33 06/27/96 3,419 JPM  1990s IPO Dogs Offer Price Price value First day Offer Company Business close 12/29/00 ($mil) date Underwriter UniCapital Equip leasing svcs $19.00 $0.00 $532 05/14/98 MSDW Webvan Group Internet retailing 24.88 0.47 375 11/04/99 Goldman NorthPoint Comm Telecom svcs 40.25 0.34 360 05/05/99 MSDW AMF Bowling Bowling centers 21.75 0.06 263 11/03/97 Goldman American Pad & Paper Office supplies 15.13 0.00 234 07/01/96 MSDW Rhythms Net Telecom svcs 69.13 1.13 197 04/06/99 Merrill Levitz Furniture Specialty retailing 14.00 0.03 182 07/02/93 MSDW Stage Stores Specialty retailing 19.25 0.02 182 10/24/96 CSFB Onvia.com Internet svcs 61.50 0.84 168 02/29/00 CSFB Starter Sports apparel 25.13 0.00 167 04/08/93 W. Blair Genesis Direct Specialty retailing 15.00 0.00 167 05/07/98 B.Stearns eToys Internet retailing 76.56 0.19 166 05/19/99 Goldman Xpedior Internet svcs 26.00 0.28 162 12/15/99 CSFB Priceline.com Internet svcs 69.00 1.31 160 03/29/99 MSDW Appendix  Role of Investment Bankers Lead investment bank must play the main role in overall coordination: Assist with due diligence Assist with document preparation (red herring, prospectus, S1) Prepare the management team of issuer Organize the road show Market and develop the book of prospective buyers Advise on pricing and size of deal Sell the shares to the public Provide market (trading) support following the sale  Legal requirements & Documents Securities Act of 1933 - Requires that a company successfully complete all registration requirements with the SEC before shares are sold to the public. Securities Exchange Act of 1934 – The 1934 Act created and granted broad powers to the SEC. It established regulation of the stock exchanges and of trading in securities after their issuance. Prospectus - A document used by the underwriter community to promote the company to prospective investors. The prospectus is also part of the SEC registration statement and discloses significant information about the company. Red Herring - The preliminary draft of the IPO prospectus. It provides the underwriting syndicate and prospective investors with information on the company before the effective date is established. Registration Statement (S1) - The disclosure document that is filed with the SEC. The registration statement contains detailed information about the company.  IPO Process: Participants Team of specialized professionals is required to prepare a company for an IPO: Board of directors Senior management Investment banks (underwriters) Legal counsel (representing the company) Legal counsel (representing underwriters) Accounting firm Printer SEC  IPO Process: Due diligence Due diligence must be thorough Accountants review historical statements and use of GAAP Key company personnel will contribute to drafting various sections of S1 document Underwriters and legal counsel review disclosures and question management Management must disclose all possible risks. This includes contingent liabilities, pending litigation, level of competition, new product risk, etc. Multiple drafting sessions will fine-tune the disclosures  IPO Process: S1 Disclosures S1 filing & Prospectus (Red Herring) contain a comprehensive description of the company Company organization and history Management profiles Description of the business Principle sources of revenue Nature of competition Potential risks Proposed use of proceeds Historical financial statements  Income statement (3 years)  Cash flow statement (3 years)  Balance sheet (2 years)  IPO Process: Marketing Role of underwriter: The lead underwriter provides overall coordination of the sales process. The lead coordinates the syndicate, identifies investors, prices the offering, and sells shares. Lead underwriter is shown on left side of prospectus Target investors: The main investors tend to be institutional investors such as pension funds, mutual funds, banks, insurance companies, hedge funds, etc. Road show: The road show is a series of presentations + Q&A sessions in major cities. Management presents the company to institutional investors. Banks are “book building” based on investor feedback Quiet period: Between prospectus filing and SEC approval, the company management cannot “hype” the stock. They should refrain from making comments or presenting forecasts or written comments that may be perceived as promoting the stock. Road show is an exception. Violations may cause the SEC to impose a “cooling off” period Tombstone: The public notice announcing the sale of stock (WSJ, section C). The tombstone shows company name, the amount offered and the underwriters.  Direct Listing A Direct Listing (also known as “Direct Placement”) is an alternative to a traditional IPO. This approach works best for large, well known, consumer facing companies (e.g. Spotify and Slack). Direct Listings had been used for insider selling. The SEC recently ruled that new capital can also be raised. Benefits Risks Existing investors (VC, founders, employees) and the Investor demand may be weaker since there is no company sell directly to the public, instead of roadshow to help generate interest. through an investment bank. There is no book-building, so the allocation process Price discovery is based purely on supply and may result in more retail holders demand indications. There is no price support from Investment banks, Companies don’t “leave money on the table” since after the stock starts trading on an exchange. No there is no difference between initial trade price and Greenshoe. the selling price of insiders. Investment banking research analysts have less Much lower fees. Companies don’t have to pay 7% of incentive to publish “Buy” reports gross proceeds to investment banks. No lock up of shares. Insiders are free to trade in the stock once it is listed.  SPAC Special Purpose Acquisition Company (“SPAC”) is a shell company, with no operations, that goes public (via an IPO) with the intention of acquiring private businesses. For private companies, this is another alternative to the IPO. SPACs are also called “blank check companies.” SPACs search for private targets with the purpose of completing a business combination. If they strike a deal, the SPAC will reverse merge with target. Thus, the private company becomes public and trades under the SPAC’s ticker. Completing the merger may take 6-8 months.