Global Equity Financing-1

Global Equity Financing-1 Global Equity Financing Prof. Ian Giddy New York University Corporate Finance CORPORATE FINANCE DECISONS INVESTMENT FINANCING RISK MGT MGT PORTFOLIO CAPITAL M&A DEBT EQUITY MEASUREMENT TOOLS Copyright 2002 Ian H. Giddy Global Equity 2

Global Equity Financing-2 Corporate Finance CORPORATE FINANCE DECISONS INVESTMENT FINANCING RISK MGT MGT PORTFOLIO CAPITAL M&A DEBT EQUITY MEASUREMENT TOOLS Copyright 2002 Ian H. Giddy Global Equity 3 Corporate Finance CORPORATE FINANCE DECISONS INVESTMENT INVESTMENT FINANCING RISK MGT MGT PORTFOLIO CAPITAL M&A FINANCING DEBT RISK EQUITY MANAGEMENT MEASUREMENT TOOLS Copyright 2002 Ian H. Giddy Global Equity 4

Global Equity Financing-3 Primary Market for Equities Private Equity Placement Initial Public Offering (IPO) Subsequent Offering Stock Buyback? Management Buyout? Copyright 2002 Ian H. Giddy Global Equity 5 Investment Banking: Organizarion Banking Coverage Corporate Finance Mergers & Acquisitions Investment Banking Fixed Income Debt Capital Markets (DCM) Syndicate Marketing Sales Institutional Retail Trading (proprietary) Risk Profits Structured Finance Credit Research Private Placement Loan Syndication Equity Equity Capital Markets (ECM) Sales Trading Research Copyright 2002 Ian H. Giddy Global Equity 6

Global Equity Financing-4 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 7 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 Engagement Due Diligence and Documentation Signing and Pricing Closing Copyright 2002 Ian H. Giddy Global Equity 8

Global Equity Financing-5 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 9 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 comanagers Senior management commitment to backing issue with people and capital Copyright 2002 Ian H. Giddy Global Equity 10

Global Equity Financing-6 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 11 Syndication: The Structure Lead Manager Book-Runner International Coordinator Co-Lead Manager Joint Co-Lead Joint Co-Lead Manager Joint Co-Lead Manager Managers Lead Lead Manager Lead Manager Managers Manager Manager Managers Selling Agent Copyright 2002 Ian H. Giddy Global Equity 12

Global Equity Financing-7 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 13 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 14

Global Equity Financing-8 What Form of Issue? Debt Equity Domestic market Asia Lat Amer Emerging Markets Foreign market (Depositary Receipts) BNY ADR Index MSCI Index (1996-98) -7.47% -28.23% -13.54% -25.64% -19.28% -36.53% Copyright 2002 Ian H. Giddy Global Equity 15 ADR (American Depository Receipts) U.S. BANK Holds shares of non-u.s. issuer on behalf of investors 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. INVESTORS LOCAL DEPOSITARY INSTITUTION Non-U.S. issuer gains better access to U.S. market and may provide superior disclosure NON-U.S. ISSUER Copyright 2002 Ian H. Giddy Global Equity 16

Global Equity Financing-9 Depositary Receipts: Alternatives Debt Equity Domestic market Foreign market (Depositary Receipts) Unsponsored Private placement Exchange traded Global issue or GDR Private placement IPO Exchange traded IPO Copyright 2002 Ian H. Giddy Global Equity 17 Equity-Linked Eurobonds Eurobonds with warrants Convertible Eurobonds Index-linked Eurobonds Copyright 2002 Ian H. Giddy Global Equity 18

Global Equity Financing-10 Equity Financing Choices Warrants Convertibles Equity ADRs Common Copyright 2002 Ian H. Giddy Global Equity 19 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 20

Global Equity Financing-11 Pricing and Fees The Issuer Fees Pricing The Business Telecoms Dot-Coms Debt 0.15% to 1.5% T+Spread L+Spread Avons (How much volatility?) Equity 5% to 7% Comparables/Ratios The market Future cash flow valuation Copyright 2002 Ian H. Giddy Global Equity 21 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 22

Global Equity Financing-12 Valuing a Firm with DCF: An Illustration Historical financial results Adjust for nonrecurring aspects Gauge future growth Projected sales and operating profits Adjust for noncash items Projected free cash flows to the firm (FCFF) Year 1 FCFF Year 2 FCFF Year 3 FCFF Year 4 FCFF Discount to present using weighted average cost of capital (WACC) 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 Copyright 2002 Ian H. Giddy Global Equity 23 Dividend Discount Models: General Model V o = Dt ( 1 + k ) t = 1 t V 0 = Value of Stock D t = Dividend k = required return Copyright 2002 Ian H. Giddy Global Equity 24

Global Equity Financing-13 Constant Growth Model Vo = Do( 1+ g) k g g = constant perpetual growth rate Copyright 2002 Ian H. Giddy Global Equity 25 Constant Growth Model: Example Vo = Do( 1+ g) k g Motel 6 has has earnings of of $5 $5 per per share. It It reinvests 40% 40% and and pays pays out out 60%dividend The The required return that that shareholders expect is is 15% 15% The The earnings are are expected to to grow at at 8% 8% per per annum What s an an M6 M6 share worth? E 1 = $5.00 b = 40% k = 15% (1-b) = 60% D 1 = $3.00 g = 8% V 0 = 3.00 / (.15 -.08) = $42.86 Plowback rate Copyright 2002 Ian H. Giddy Global Equity 26

Global Equity Financing-14 Shifting Growth Rate Model V o = g D T ( 1+ 1 ) o t ( 1+ k) t= 1 t DT( 1+ g2) + ( k g2)( 1+ k) T g 1 = first growth rate g 2 = second growth rate T = number of periods of growth at g 1 Copyright 2002 Ian H. Giddy Global Equity 27 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 28

Global Equity Financing-15 The Weighted Average Cost of Capital Choice Cost 1. 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 Capital Asset Pricing Model (CAPM) 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) Bond Pricing Debt + equity = Cost of capital = Weighted average of cost of equity and Capital cost of debt; weights based upon market value. Cost of capital = k d [D/(D+E)] + k e [E/(D+E)] WACC Copyright 2002 Ian H. Giddy Global Equity 29 The Cost of Equity Depends on the Company s Risk Premium r j = R F + β j (r m - R F ) where: r j = Required return on asset j; R F = Risk-free rate of return β j = Beta Coefficient for asset j; r m = Market return The term [β j (r m - R F )] is called the risk premium and (r m -R F ) is called the market risk premium Copyright 2002 Ian H. Giddy Global Equity 30

Global Equity Financing-16 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 P or TOTAL RISK t f o li DIVERSIFIABLE RISK o R is k s kp NONDIVERSIFIABLE RISK 1 5 10 15 20 25 Number of Securities (Assets) in Portfolio Copyright 2002 Ian H. Giddy Global Equity 32

Global Equity Financing-17 The Global Efficient Frontier AVERAGE RETURN % PA 30 STOCKS AND BONDS STOCKS ONLY 25 20 15 EAFE STOCKS & BONDS EAFE STOCKS 10 5 5 WORLD STOCKS & BONDS WORLD STOCKS US STOCKS US STOCKS & BONDS US BONDS RISK, % PA 10 15 20 25 30 Copyright 2002 Ian H. Giddy Global Equity 33 Returns with FX Return in US is a function of two factors 1. Return in the foreign market 2. Return on the foreign exchange Copyright 2002 Ian H. Giddy Global Equity 34

Global Equity Financing-18 Returns with FX (1 + r US ) = (1 + r FM ) (1 + r FX ) r US = return on the foreign investment in US Dollars r FM = return on the foreign market in local currency r FX = return on the foreign exchange Copyright 2002 Ian H. Giddy Global Equity 35 Example ROI with FX Change Local currency ROI 17% Rate of change of the exchange rate -8% Foreign currency ROI 7.64% Source: giddy.org Web Resources Copyright 2002 Ian H. Giddy Global Equity 36

Global Equity Financing-19 Raising and Pricing Equity Prof. Ian Giddy New York University Raising Equity: The Investment Banker s Job Market conditions Corporate needs Valuation Information Distribution Telekom Copyright 2002 Ian H. Giddy Global Equity 38

Global Equity Financing-20 Deutsche Telekom: The Sequence See case Exhibit 2 Copyright 2002 Ian H. Giddy Global Equity 39 What s a Company Worth to Investors? Required Returns Types of Models Telekom Balance sheet models Dividend discount & corporate cash flow models Price/Earnings ratios Option models Estimating Growth Rates Copyright 2002 Ian H. Giddy Global Equity 40

Global Equity Financing-21 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 41 Deutsche Telekom: Book Value See case Exhibit 3 Copyright 2002 Ian H. Giddy Global Equity 42

Global Equity Financing-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 43 Deutsche Telekom: Ratios and Comparables See case page 9 Copyright 2002 Ian H. Giddy Global Equity 44

Global Equity Financing-23 Discounted Cashflow Valuation: Basis for Approach where Value = n = Life of the asset t=n CF t t=1(1+r) t CF t = Cashflow in period t r = Discount rate reflecting the riskiness of the estimated cashflows Copyright 2002 Ian H. Giddy Global Equity 45 Deutsche Telekom: Earnings See case page 8 Copyright 2002 Ian H. Giddy Global Equity 46

Global Equity Financing-24 Valuing a Firm with DCF: An Illustration Historical financial results Adjust for nonrecurring aspects Gauge future growth Projected sales and operating profits Adjust for noncash items Projected free cash flows to the firm (FCFF) Year 1 FCFF Year 2 FCFF Year 3 FCFF Year 4 FCFF Discount to present using weighted average cost of capital (WACC) 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 Copyright 2002 Ian H. Giddy Global Equity 47 What s a Company Worth? Alternative Models The options approach Option to expand Option to abandon Creation of key resources that another company would pay for Patents or trademarks Teams of employees Customers Examples? Lycos Messageclick.com Copyright 2002 Ian H. Giddy Global Equity 48

Global Equity Financing-25 Raising Equity: The Investment Banker s Job Market conditions Corporate needs Valuation Information Distribution Telekom T-Online Copyright 2002 Ian H. Giddy Global Equity 49 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 Copyright 2002 Ian H. Giddy Global Equity 54