prof. ian giddy new york university global equity financing
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Prof. Ian GiddyNew York University
Global EquityFinancing
Copyright ©2002 Ian H. Giddy Global Equity 2
Corporate Finance
CORPORATE FINANCE
DECISONS
CORPORATE FINANCE
DECISONS
INVESTMENTINVESTMENT RISK MGTRISK MGTFINANCINGFINANCING
CAPITAL
PORTFOLIO
M&ADEBT EQUITY
TOOLS
MEASUREMENT
Copyright ©2002 Ian H. Giddy Global Equity 3
Corporate Finance
CORPORATE FINANCE
DECISONS
CORPORATE FINANCE
DECISONS
INVESTMENTINVESTMENT RISK MGTRISK MGTFINANCINGFINANCING
CAPITAL
PORTFOLIO
M&ADEBT EQUITY
TOOLS
MEASUREMENT
Copyright ©2002 Ian H. Giddy Global Equity 4
Corporate Finance
CORPORATE FINANCE
DECISONS
CORPORATE FINANCE
DECISONS
INVESTMENTINVESTMENT RISK MGTRISK MGTFINANCINGFINANCING
CAPITAL
PORTFOLIO
M&ADEBT EQUITY
TOOLS
MEASUREMENT
INVESTMENT
FINANCINGRISK
MANAGEMENT
Copyright ©2002 Ian H. Giddy Global Equity 5
Primary Market for Equities
Initial Public Offering (IPO)
Subsequent Offering
Private Equity Placement
Stock Buyback?
Management Buyout?
Copyright ©2002 Ian H. Giddy Global Equity 6
EquityBanking Fixed Income
Investment Banking: Organizarion
“Coverage”
•Corporate Finance•Mergers & Acquisitions•Investment Banking
Debt Capital Markets (DCM)
•Syndicate•Marketing
Sales•Institutional•Retail
Trading (proprietary)•Risk •Profits
Structured FinanceCredit ResearchPrivate PlacementLoan Syndication
Equity Capital Markets (ECM)
•Sales•Trading•Research
Copyright ©2002 Ian H. Giddy Global Equity 7
Investment Banking: Organization
New Deal Pitch Team Coverage/
Investment banking Product (DCM or
ECM)
Commitment Committee Investment banking ECM/DCM Senior sales/trading Research
Copyright ©2002 Ian H. Giddy Global Equity 8
Underwriting Sequence
Engagement: Mandate signed by issuer engaging lead manager
Due Diligence: Conducted by Lead manager
Documentation: Loan agreement, Prospectus
Signing: Underwriting agreement signed and issue priced
Closing: Settlement of the offering
EngagementEngagement
Due Diligence and
Documentation
Due Diligence and
Documentation
Signing and PricingSigning and Pricing
ClosingClosing
Copyright ©2002 Ian H. Giddy Global Equity 9
The Beauty Contest
Criteria for Selecting a Lead Manager 1 Experience with similar transactions (sector,
market, currency, maturity, high or low-quality issuers)
Ranking in League Tables Placement power with institutional and/or
retail investors Standing in secondary market as “market
maker” and commitment to secondary market trading
Copyright ©2002 Ian H. Giddy Global Equity 10
The Beauty Contest (Cont.)
Criteria for Selecting a Lead Manager 2 Quality/reputation of research Proposed marketing strategy (pricing,
timing, issue size, etc.) Proposals for “Roadshow” Relationships with potential co-
managers Senior management commitment to
backing issue with people and capital
Copyright ©2002 Ian H. Giddy Global Equity 11
The Roadshow
Organized by global coordinator and lead managers
Informal presentation by management to potential investors
Attendance limited to professional intermediaries and investing institutions
Content must be consistent with information in draft version of prospectus or offering circular.
Copyright ©2002 Ian H. Giddy Global Equity 12
Syndication: The Structure
Lead ManagerBook-Runner
“International Coordinator
Joint Co-Lead
ManagerJoint Co-Lead
ManagerJoint Co-Lead
Managers
Lead
ManagerLead
ManagerLead
Managers
ManagerManagerManagers Selling Agent
Co-Lead Manager
Copyright ©2002 Ian H. Giddy Global Equity 13
Securities Underwriting: Relationships
Issuer
Agents Investment Bankers
Debt: Fiscal agent
Equity:
Depositary institution
Lead manager/Bookrunner
Registered offering: Underwriting Agreement
Unregistered: Purchase Agreement
Co-managers
Agreement Among Underwriters
Prospectus/Offering Circular
Institutional Buyers Retail Buyers
Copyright ©2002 Ian H. Giddy Global Equity 14
Subscription or Underwriting Agreement Between issuer, global coordinator and all managers Signed after pricing when “book-building” completed Firm commitment to underwrite, subject to delivery of
certain confirmatory certificates and no “material adverse change” or “force majeure”
Indemnity: By the issuer in favor of Global Coordinator and Managers against liability arising as a breach of warranty, material inaccuracy or omission
Lock up: Issuer will not offer other securities for a period of time (eg six months)
Copyright ©2002 Ian H. Giddy Global Equity 15
Debt
Equity
Domestic market
Foreign market(Depositary Receipts)
BNY ADR Index
-7.47%-13.54%-19.28%
MSCI Index
-28.23%-25.64%-36.53%
AsiaLat AmerEmerging Markets
(1996-98)
What Form of Issue?
Copyright ©2002 Ian H. Giddy Global Equity 16
ADR (American Depository Receipts)
INVESTORS
LOCAL
DEPOSITARY
INSTITUTION
U.S. BANK U.S. investor buys certificate which represents a foreign market security. It receives the same treatment as a U.S. security and trades freely in the U.S.
Holds shares of non-U.S. issuer on behalf of investors
NON-U.S.
ISSUER
Non-U.S. issuer gains better access to U.S. market and may provide superior disclosure
Copyright ©2002 Ian H. Giddy Global Equity 17
Debt
Equity
Domestic market
Foreign market(Depositary Receipts)
Unsponsored Private placement
Exchange traded
Exchange traded IPO
Private placement IPO
Global issue or GDR
Depositary Receipts: Alternatives
Copyright ©2002 Ian H. Giddy Global Equity 18
Equity-Linked Eurobonds
Eurobonds with warrantsMarui
Convertible EurobondsBattle Mountaingold
Index-linked EurobondsBank of Montreal
Copyright ©2002 Ian H. Giddy Global Equity 19
Equity Financing Choices
Equity
Warrants Conver-tibles
ADRs Common
Copyright ©2002 Ian H. Giddy Global Equity 20
Pricing
Debt Instruments Bonds priced according
to yield over benchmark (spread)
Yield too low – issue does not sell
Yield too high – too much given away
Generally syndicate holds price for a day; in a successful issue yields gradually tighten
Equity Mature issue: based on
current market price and market conditions, small premium for dilution; comparables
IPO: comparables and discounted cash flow analysis
Copyright ©2002 Ian H. Giddy Global Equity 21
Pricing and Fees
The Business Telecoms Dot-Coms Avons(How much volatility?)
Debt
Equity
Fees
0.15%
to
1.5%
5% to
7%
PricingT+Spread
L+Spread
Comparables/Ratios
The market
Future cash flow valuation
The Issuer
Copyright ©2002 Ian H. Giddy Global Equity 22
Relative Valuation
Do valuation ratios make sense?• Price/Earnings (P/E) ratios
and variants (EBIT multiples, EBITDA multiples, Cash Flow multiples)
• Price/Book (P/BV) ratios and variants (Tobin's Q)
• Price/Sales ratios
It depends on how they are used -- and what’s behind them!
Copyright ©2002 Ian H. Giddy Global Equity 23
Valuing a Firm with DCF: An Illustration
Historical financial results
Adjust for nonrecurring aspects
Gauge future growth
Adjust for noncash items
Projected sales and operating profits
Projected free cash flows to the firm (FCFF)
Year 1 FCFF
Year 2 FCFF
Year 3 FCFF
Year 4 FCFF
Terminal year FCFF
Stable growth model or P/E comparable
Present value of free cash flows
+ cash, securities & excess assets
- Market value of debt
Value of shareholders equity
…
Discount to present using weighted average cost of capital (WACC)
Copyright ©2002 Ian H. Giddy Global Equity 24
Dividend Discount Models:General Model
VD
ko
t
tt
( )11
VD
ko
t
tt
( )11
V0 = Value of Stock Dt = Dividend k = required return
Copyright ©2002 Ian H. Giddy Global Equity 25
Constant Growth Model
VoD g
k g
o
( )1Vo
D g
k g
o
( )1
g = constant perpetual growth rate
Copyright ©2002 Ian H. Giddy Global Equity 26
Constant Growth Model: Example
VoD g
k g
o
( )1Vo
D g
k g
o
( )1
E1 = $5.00b = 40% k = 15%
(1-b) = 60% D1 = $3.00 g = 8%
V0 = 3.00 / (.15 - .08) = $42.86
Motel 6 has earnings of $5 per share. It reinvests 40% and pays out 60%dividend
The required return that shareholders expect is 15%
The earnings are expected to grow at 8% per annum
What’s an M6 share worth?
Motel 6 has earnings of $5 per share. It reinvests 40% and pays out 60%dividend
The required return that shareholders expect is 15%
The earnings are expected to grow at 8% per annum
What’s an M6 share worth?
Plowback rate
Copyright ©2002 Ian H. Giddy Global Equity 27
Shifting Growth Rate Model
V Dg
k
D g
k g ko o
t
tt
TT
T
( )
( )
( )
( )( )
1
1
1
1
1
1
2
2V D
g
k
D g
k g ko o
t
tt
TT
T
( )
( )
( )
( )( )
1
1
1
1
1
1
2
2
g1 = first growth rate g2 = second growth rate T = number of periods of growth at g1
Copyright ©2002 Ian H. Giddy Global Equity 28
The Investors’ Viewpoint:Equity Risk and Return
Investors diversify, because you get a better return for a given risk.
There is a fully-diversified “market portfolio” that we should all choose
The risk of an individual asset can be measured by how much risk it adds to the “market portfolio.”
But does this apply to the global capital market?
Copyright ©2002 Ian H. Giddy Global Equity 29
The Weighted Average Cost of Capital
Choice Cost1. Equity Cost of equity
- Retained earnings - depends upon riskiness of the stock
- New stock issues - will be affected by level of interest rates
- Warrants
Cost of equity = riskless rate + beta * risk premium
2. Debt Cost of debt
- Bank borrowing - depends upon default risk of the firm
- Bond issues - will be affected by level of interest rates
- provides a tax advantage because interest is tax-deductible
Cost of debt = Borrowing rate (1 - tax rate)
Debt + equity = Cost of capital = Weighted average of cost of equity and
Capital cost of debt; weights based upon market value.
Cost of capital = kd [D/(D+E)] + ke [E/(D+E)]
Copyright ©2002 Ian H. Giddy Global Equity 30
International Equity Markets and Portfolio Diversification
No well-accepted international version of the capital asset pricing model.
The benefits of diversification globally are empirical issues.
The empirical case for international diversification has two components. Establish the riskiness of foreign investment, and the extent
to which combining a foreign with a domestic portfolio reduces risk.
Even if it reduces risk, does foreign investment also reduce expected return?
Then what we have to do is make sure we understand how international diversification is best achieved.
Copyright ©2002 Ian H. Giddy Global Equity 31
International Diversification Pays More
Portfolio
Risk
kp
Number of Securities (Assets) in Portfolio1 5 10 15 20 25
TOTAL RISK
NONDIVERSIFIABLE RISK
DIVERSIFIABLE RISK
Copyright ©2002 Ian H. Giddy Global Equity 32
The Global Efficient Frontier
10 15 20 25 30 5
5
10
15
20
25
30
STOCKSANDBONDS
STOCKSONLY
EAFESTOCKS& BONDS
EAFE STOCKS
WORLD STOCKS & BONDS
WORLD STOCKS
US STOCKS & BONDSUS STOCKS
US BONDS
AVERAGE RETURN% PA
RISK, % PA
Prof. Ian GiddyNew York University
Raising and PricingEquity
Copyright ©2002 Ian H. Giddy Global Equity 34
Raising Equity: The Investment Banker’s Job
Market conditions Corporate needs Valuation Information Distribution
Telekom
Telekom
Copyright ©2002 Ian H. Giddy Global Equity 35
Deutsche Telekom: The Sequence
See case Exhibit 2
Copyright ©2002 Ian H. Giddy Global Equity 36
What’s a Company Worthto Investors?
Required Returns Types of Models
Balance sheet modelsDividend discount & corporate cash flow
modelsPrice/Earnings ratiosOption models
Estimating Growth Rates
Telekom
Telekom
Copyright ©2002 Ian H. Giddy Global Equity 37
Equity Valuation: From the Balance Sheet
Value of Assets Book Liquidation Replacement
Value of Liabilities
Book Market
Value of Equity
Copyright ©2002 Ian H. Giddy Global Equity 38
Deutsche Telekom: Book Value
See case Exhibit 3
Copyright ©2002 Ian H. Giddy Global Equity 39
Relative Valuation
Do valuation ratios make sense?• Price/Earnings (P/E) ratios
and variants (EBIT multiples, EBITDA multiples, Cash Flow multiples)
• Price/Book (P/BV) ratios and variants (Tobin's Q)
• Price/Sales ratios
It depends on how they are used -- and what’s behind them!
Copyright ©2002 Ian H. Giddy Global Equity 40
Deutsche Telekom:Ratios and Comparables
See case page 9
Copyright ©2002 Ian H. Giddy Global Equity 41
Discounted Cashflow Valuation: Basis for Approach
where n = Life of the asset CFt = Cashflow in period t r = Discount rate reflecting the
riskiness of the estimated cashflows
Value = CFt
(1+ r)tt =1
t = n
Copyright ©2002 Ian H. Giddy Global Equity 42
Deutsche Telekom: Earnings
See case page 8
Copyright ©2002 Ian H. Giddy Global Equity 43
Valuing a Firm with DCF: An Illustration
Historical financial results
Adjust for nonrecurring aspects
Gauge future growth
Adjust for noncash items
Projected sales and operating profits
Projected free cash flows to the firm (FCFF)
Year 1 FCFF
Year 2 FCFF
Year 3 FCFF
Year 4 FCFF
Terminal year FCFF
Stable growth model or P/E comparable
Present value of free cash flows
+ cash, securities & excess assets
- Market value of debt
Value of shareholders equity
…
Discount to present using weighted average cost of capital (WACC)
Copyright ©2002 Ian H. Giddy Global Equity 44
What’s a Company Worth?Alternative Models
The options approachOption to expandOption to abandon
Creation of key resources that another company would pay forPatents or trademarksTeams of employeesCustomers
Examples?
Lycos
Lycos
Messageclick.com
Messageclick.com
Copyright ©2002 Ian H. Giddy Global Equity 45
Raising Equity: The Investment Banker’s Job
Market conditions Corporate needs Valuation Information Distribution
Telekom
Telekom
T-Online
T-Online
Copyright ©2002 Ian H. Giddy Global Equity 50
Contact
Ian H. Giddy
NYU Stern School of Business
44 West 4th Street, New York, NY 10024, USA
Tel 212-998-0426
ian.giddy@nyu.edu
http://giddy.org
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