Chapter 12 Sourcing Equity Globally
Sourcing Equity Globally: Learning Objectives Design a strategy to source equity globally Analyze the motivations and goals of a firm issuing new equity shares on foreign equity markets Analyze the motivations and goals of a firm issuing new equity shares on foreign equity markets Recognize the many barriers to penetrate effectively foreign equity markets through cross-listing and selling equity abroad Identify the various financial instruments which can be used to source equity in the global equity markets Copyright 2006 Pearson Addison-Wesley. All rights reserved. 12-2
Designing a Strategy to Source Equity Globally This requires management to agree upon a long-run financial objective and then choose among various alternative paths to get there Normally the choice of paths and implementation is aided by an early appointment of an investment bank as official advisor to the firm Investment bankers are in touch with the potential foreign investors and what they require in terms of risk/reward Investment bankers can also help navigate the various institutional requirements and barriers that must be satisfies to source equity globally Copyright 2006 Pearson Addison-Wesley. All rights reserved. 12-3
Designing a Strategy to Source Equity Globally Most firms raise their initial capital in their own domestic market While many can be tempted to skip the intermediate steps to complete an Euroequity issue in global markets, good financial advisors will offer a reality check on this strategy Most firms that have only raised capital in their domestic market are not well enough known to attract foreign investors The following exhibit walks through a more probable chain of events in accessing global capital markets with the end goal being equity capital Copyright 2006 Pearson Addison-Wesley. All rights reserved. 12-4
Alternative Paths Domestic Financial Market Operations International Bond Issue -- Less Liquid Markets International Bond Issue -- Target Market or Eurobond Market Equity Listings -- Less Liquid Markets Equity Issue -- Less Liquid Markets Equity Listing -- Target Market Euro equity Issue -- Global Markets Copyright 2006 Pearson Addison-Wesley. All rights reserved. 12-5
Sourcing Equity Globally Depositary Receipts Depositary receipts are negotiable certificates issued by a bank to represent the underlying shares of stock, which are held in trust at a foreign custodian bank Global Depositary Receipts (GDRs) refers to certificates traded outside the US American Depositary Receipts (ADRs) are certificates traded in the US and denominated in US dollars ADRs are sold, registered, and transferred in the US in the same manner as any share of stock with each ADR representing some multiple of the underlying foreign share Copyright 2006 Pearson Addison-Wesley. All rights reserved. 12-6
Sourcing Equity Globally Depositary Receipts This multiple allows the ADRs to possess a price per share conventional for the US market ADRs are either sponsored or unsponsored Sponsored ADRs are created at the request of a foreign firm wanting its shares traded in the US; the firm applies to the SEC and a US bank for registration and issuance Copyright 2006 Pearson Addison-Wesley. All rights reserved. 12-7
American Depositary Receipts Shares Shares held on deposit at custodial bank Receipts Publicly traded firm outside the U.S. Receipts for shares listed on U.S. exchange Shares Shares traded on local stock exchange Traded by U.S. investors Arbitrage Activity Copyright 2006 Pearson Addison-Wesley. All rights reserved. 12-8
Depositary Receipt Programs Copyright 2006 Pearson Addison-Wesley. All rights reserved. 12-9
Foreign Equity Listing & Issuance By cross-listing and selling its shares on a foreign stock exchange a firm typically tries to accomplish one or more of the following objectives: Improve the liquidity of its existing shares and support a liquid secondary market Increase its share price by overcoming mispricing in a segmented and illiquid home market Increase the firm s visibility and political acceptance to its customers, suppliers, creditors & host governments Establish a secondary market for shares used for acquisitions Create a secondary market for shares that can be used to compensate local management and employees in foreign subsidiaries Copyright 2006 Pearson Addison-Wesley. All rights reserved. 12-10
Foreign Equity Listing & Issuance Cross-listing is a way to encourage investors to continue to hold and trade shares that may or may not be listed on an investors home market or in a preferred currency Cross-listing is usually done through ADRs (in the United States, where they are traded and quoted in U.S. dollars) GRSs, on the other hand, are able to be traded on equity exchanges around the globe in a variety of currencies and are traded electronically Copyright 2006 Pearson Addison-Wesley. All rights reserved. 12-11
Global Registered Shares (GRSs) German Equity System German investors can trade in equities listed on any of the three exchanges, but quoted in local currency ( ) Electronic Linkages Swiss Equity System Swiss investors can trade in equities listed on any of the three exchanges, but quoted in local currency (Sfr) Electronic Linkages New York Stock Exchange U.S. & Canadian investors can trade in equities listed on any of the three exchanges, but quoted in local currency, the US$ in the US and the C$ in Canada Copyright 2006 Pearson Addison-Wesley. All rights reserved. 12-12
Effect of Cross-Listing on Share Price The impact on price of cross-listing on a foreign stock market depends on the degree to which the markets are segmented As was the situation experienced by Novo, a firm can benefit if a foreign market values a company more highly than a home market (in a highly-segmented situation) Copyright 2006 Pearson Addison-Wesley. All rights reserved. 12-13
Other Motives for Cross-Listing Increasing visibility and political acceptance MNEs list in markets where they have substantial physical operations Political objectives might include the need to meet local ownership requirements for an MNE s foreign joint venture Increasing potential for share swaps with acquisitions Compensating management and employees Copyright 2006 Pearson Addison-Wesley. All rights reserved. 12-14
Barriers to Cross-Listing and Selling Equity Abroad Commitment to disclosure and investor relations A decision to cross-list must be balanced against the implied increased commitment to full disclosure and a continuing investor relations program Disclosure is a double-edged sword Increased firm disclosure should have the effect of lowering the cost of equity capital On the other hand, this increased disclosure is a costly burden to corporations Copyright 2006 Pearson Addison-Wesley. All rights reserved. 12-15
Alternative Instruments to Source Equity Alternative instruments to source equity in global markets include the following: Sale of a directed public share issue to investors in a target market Sale of a Euro equity public issue to investors in more than one market, including both foreign and domestic markets Private placements under SEC Rule 144A Sale of shares to private equity funds Sale of shares to a foreign firm as a part of a strategic alliance Copyright 2006 Pearson Addison-Wesley. All rights reserved. 12-16
Alternative Instruments to Source Equity Directed Public Share Issues Defined as one which is targeted at investors in a single country and underwritten in whole or in part by investment institutions from that country Issue may or may not be denominated in the currency of the target market The shares might or might not be cross-listed on a stock exchange in the target market A foreign share issues, plus cross-listing can provide it with improved liquidity Copyright 2006 Pearson Addison-Wesley. All rights reserved. 12-17
Alternative Instruments to Source Equity Euroequity Public Issue Gradual integration of worlds capital markets has spawned the emergence of a Euroequity market A firm can now issue equity underwirtten and distributed in multiple foreign equity markets; sometimes simultaneously with distribution in the domestic market As we have reviewed, the term Euro does not imply that the issuers or investors are located in Europe, nor does it mean the shares are sold in the currency euro Copyright 2006 Pearson Addison-Wesley. All rights reserved. 12-18
Alternative Instruments to Source Equity Private Placement Under SEC Rule 144A A private placement is the sale of a security to a small set of qualified institutional buyers Investors are traditionally insurance companies and investment companies Because shares are not registered for sale, investors typically follow buy and hold strategy Rule 144A allows qualified institutional buyers (QIB) to trade privately placed securities without previous holding period restrictions and without requiring SEC registration Copyright 2006 Pearson Addison-Wesley. All rights reserved. 12-19
Alternative Instruments to Source Equity Private Equity Funds Limited partnerships of institutional and wealthy individual investors that raise their capital in the most liquid capital markets Then invest these funds in mature, familyowned firms located in emerging markets Strategic Alliances Normally followed by firms that expect to gain synergies from one or more joint efforts Copyright 2006 Pearson Addison-Wesley. All rights reserved. 12-20
Summary of Learning Objectives Designing a capital sourcing strategy requires management to agree upon a long run financial objective The firm must then choose among the various alternative paths to get there, including where to cross-list its shares and where to issue new equity and in what form Copyright 2006 Pearson Addison-Wesley. All rights reserved. 12-21
Summary of Learning Objectives A firm cross-lists its shares on foreign stock exchanges for one or more of the following reasons Improving liquidity of its existing shares through depositary receipts Increase its share price by overcoming mispricing by a segmented, illiquid home market Support a new equity issue sold in a foreign market Establish a secondary market for shares used in acquisitions Increase the firm s visibility & political acceptance to its customers, suppliers, creditors and host governments Create a secondary market for shares that will be used to compensate local management and employees in foreign subsidiary Copyright 2006 Pearson Addison-Wesley. All rights reserved. 12-22
Summary of Learning Objectives If it is to support a new equity issue or to establish a market for share swaps, the target market should also be the listing market If it is to increase the firm s commercial and political visibility or to compensate local management and employees, it should be in markets in which the firm has significant operations The major liquid stock markets are the NYSE, NASDAQ, LSE, Euronext, Tokyo, and Deutsche Bourse Copyright 2006 Pearson Addison-Wesley. All rights reserved. 12-23
Summary of Learning Objectives By cross-listing and selling equity abroad, a firm faces two barriers Increased commitment to full disclosure A continuing investor relations program Non-U.S. firms must think twice before crosslisting in the United States. Not only are the disclosure requirements onerous, but continuous timely quarterly information is required by U.S. regulators and investors. This is very costly. Copyright 2006 Pearson Addison-Wesley. All rights reserved. 12-24
Summary of Learning Objectives A firm can lower its cost of capital and increase its liquidity by selling its shares to foreign investors in a variety of forms Sale of a directed share issue to investors in one particular foreign equity market Sale of a Euroequity share issue to foreign investors simultaneously in more than one market, including both foreign and domestic markets Private placement under SEC rule 144A Sale of shares to private equity funds Sales of shares to a foreign firm as part of a strategic alliance Copyright 2006 Pearson Addison-Wesley. All rights reserved. 12-25
Mini-Case: Deutsche Bank s Global Registered Shares Since 1927 foreign companies have listed their shares on the New York Stock Exchange by issuing ADRs Foreign companies have found the ADR system a very corporate-friendly system by which foreign corporations could reach investors in the New York equity capital markets In October 2001, Deutsche Bank of Germany decided to list via GRSs instead of ADRs Copyright 2006 Pearson Addison-Wesley. All rights reserved. 12-26
Mini-Case: Deutsche Bank s Global Registered Shares Do you believe the differences between ADRs and GRSs are real or cosmetic? Why? Why do you think Deutsche Bank would proceed with a GRS listing when so many others have not? What do you think Deutsche Bank concluded from DaimlerChrysler s experience with GRSs? Copyright 2006 Pearson Addison-Wesley. All rights reserved. 12-27
Exhibit 12.1 Alternative Paths to Globalize the Cost and Availability of Capital Copyright 2006 Pearson Addison-Wesley. All rights reserved. 12-28
Exhibit 12.2 Mechanics of American Depositary Receipts (ADRs) Copyright 2006 Pearson Addison-Wesley. All rights reserved. 12-29
Exhibit 12.3 Characteristics of Depositary Receipt Programs Traded in the United States Copyright 2006 Pearson Addison-Wesley. All rights reserved. 12-30
Exhibit 12.4 Global Registered Shares Copyright 2006 Pearson Addison-Wesley. All rights reserved. 12-31
Exhibit 12.5 Selected Stock Exchange Size Characteristics and Market Liquidity, End 2002 Copyright 2006 Pearson Addison-Wesley. All rights reserved. 12-32
Exhibit 1 Copyright 2006 Pearson Addison-Wesley. All rights reserved. 12-33