Issuing Securities to the Public
Adapted from Fundamentals of Corporate Finance RWJR, Fourth Canadian Edition
(Chapter 4)
Types of offerings
Private placements
Public issue: cash offers (IPO or SEO) and rights offerings
Private placement vs. public issue
Private placements (dedicated placements): Sold directly to a
small number of investors
•
less stringent disclosure requirements
•
faster completion of the offer
•
less marketable
•
higher yield
Public issue: securities are sold to the public with the help of
investment dealers; the investment dealers act as underwriters;
they take on some or all of the pricing risk in the new issue.
The public issue
The basic procedure:
 The management gets approval from the board of directors
 The preliminary prospectus (red herring) is prepared and
distributed to the OSC and potential investors
 Once the OSC gives the approval, the final prospectus is
distributed and the underwriting syndicate is formed
The regulation of issuing securities
In order to be eligible for issuing securities to be traded over the
counter or on the TSE, Canadian companies have to meet certain
requirements.
These requirements are set by a regulatory authority and involve,
among other things, the standardized disclosure of critical
information pertaining to the firm's activities and financial standing.
The regulation of issuing securities
 By the SEC in the US
 By provincial regulatory bodies in Canada
Types of underwriting
 Best efforts underwriting
 Regular underwriting
 Firm commitment underwriting (no out clause)
 Bought Deal (mostly for firms that qualify for POPs)
Case: Magin Energy Inc. announces share issue
CALGARY, Dec. 9 /CNW/ - Magin Energy Inc. announced that it has entered into an
agreement for the issuance of up to 3,200,000 common shares at $3.40 per share. The
flow-through common shares will be issued through Griffiths McBurney & Partners, as to
2,000,000 shares ($6,800,000) on a bought deal basis and up to 1,200,000 shares
($4,080,000) on a best efforts agency basis. Proceeds of the issuance will be used to fund
exploration expenditures and Magin will renounce to subscribers Canadian exploration
expenses equal to the subscription amount for the shares.
Closing of this issue is subject to customary regulatory approval and is anticipated to occur
within two weeks.
Magin Energy Inc. currently has 26.9 million common shares outstanding and is a
balanced oil and gas producer that expects to exit 1998 with 10,000 barrels of oil
equivalent per day of production.
DESTINATION RESORTS INC. ANNOUNCES
$15,000,000 UNDERWRITTEN FINANCING
CALGARY, May 25 /CNW/ - The Corporation is pleased to announce that it has entered into an
agreement with Research Capital Corporation (``Research Capital'') on May 22, 1998 in connection with
a proposed $15,000,000 special warrant financing. Pursuant to the agreement the Corporation will issue
2,150,000 special warrants which will be marketed on an underwritten basis by Research Capital. Each
special warrant will entitle its holder to acquire without payment of any additional consideration one
common share of the Corporation. A green shoe option will permit the issuance of up to 350,000
additional special warrants to cover over-allotments. The Corporation will use the proceeds from the
financing to develop and market its recently acquired Quail Ridge properties near Kelowna, British
Columbia and to expand its development activities elsewhere. 50% of the proceeds of the financing will
be held in escrow and will be released on the earlier of (i) the unconditional closing of the Quail Ridge
acquisition; or (ii) the receipt of the final prospectus qualifying the offering. In the event a final receipt for
the prospectus is not received by September 17, 1998 each special warrant will entitle its holder to
acquire 1.1 common shares instead of one common share. The private placement is expected to close
on or about June, 11, 1998 at which time 50% of the proceeds will be
immediately available to the Corporation.
The Corporation is traded under the symbol ``DRO'' on The Toronto Stock Exchange.
The Toronto Stock Exchange has neither approved nor disapproved the information contained herein.
The costs of issuing securities (flotation costs)
 The spread
 Other direct expenses
 Green Shoe option
 Underpricing (IPOs)/lost market value (SEOs)
Rights offering
The shareholders are given the option (right) of buying a new issue
of common stock on a pro-rata basis, at a pre-determined
price; hence they can:
•
exercise their rights
•
sell their right
Rights offering: Time line
• Announcement date
• Cum rights date: the last day when a share comes with a right
attached to it
• Ex-rights date: first day when rights are separate from shares
• Holder-of-Record date: the day when the list of rights holders is
compiled
• Expiration date: the last day when a right can be exercised
Rights valuation
theoretical value of a right:
(share price rights on - subscription price)/(N+1) or
(share price ex-rights - subscription price)/N
In theory, rights offerings should leave the shareholder ‘s
wealth unaffected (similar to stock splits)
Rights are usually issued based on standby underwriting
arrangements:
 standby fee
 oversubscription privilege
Phonettix Intelecom Ltd.
RICHMOND HILL, ON, Jan. 14 /CNW/
Subject to obtaining the consent of applicable regulatory authorities, Phonettix has agreed to
issue 4,959,892 common shares pursuant to a rights offering. Under the rights offering, each
holder of common shares will be entitled to one right for each common share held as of a record
date to be determined; and four rights will confer the right to purchase one common share. The
subscription price per common share shall be four rights and $0.40 per common share. Of the
gross proceeds of $1,983,956.80, $1 million will be
used for working capital and the remainder will be used to reduce the outstanding current debt of
Phonettix. Any holder of rights certificates will be allowed to exercise the right to subscribe for all
the common shares that can be subscribed for with the rights evidenced by such certificate and
will have the privilege of subscribing for additional common shares at the subscription price.
Dorothy Millman, the indirect holder of 5,620,481 common shares (or 28.3% of the issued and
outstanding common shares), has agreed to subscribe for 225,000 common shares and
institutional shareholders holding 3,669,500 common shares (or 18.5% of the issued and
outstanding common shares) have agreed to subscribe for the remaining common shares
issuable under this offering, subject to the right of all shareholders to subscribe for their pro rata
portion of the rights offering. As a result, the rights offering has been fully subscribed for. It is
expected that the rights offering will close in early March.
CSI to proceed with rights offering
Canaccord Capital Corporation Retained to Manage Rights Offering
Toronto Stock Exchange Symbol: CSY
CALGARY, Jan. 31 /CNW/ - Communication Systems International ("CSI"), a leading supplier of high
accuracy differential global positioning system ("DGPS") technologies and products, is pleased to
announce today that, subject to final regulatory approval, it is proceeding with a rights offering to its
shareholders to raise approximately $2,300,000. Shareholders of record at the close of business on
February 18, 2000, will be entitled to receive one right for each common share held. Four rights will
entitle the holder to purchase one common share at a subscription price of Cdn. $1.60, for an
aggregate of up to 1,591,031 common shares. The rights expire at 5:00 p.m. (Calgary time) on March
14, 2000. Holders who exercise their rights in full will be entitled to subscribe for additional common
shares, if any remain available, on a pro rata basis. Under the rights offering, rights will only be
delivered to, and subscriptions for common shares will only be accepted from, residents of the
provinces of British Columbia, Alberta, Saskatchewan, Manitoba, Ontario and Québec.
A circular in respect of the rights offering will be mailed to holders of record on February 18, 2000 as
soon as practicable after that date. Canaccord Capital Corporation has been retained by CSI to solicit
subscriptions for common shares from CSI's shareholders and to assist shareholders who do not wish
to exercise their rights, to sell the rights to persons who will exercise them. The proceeds of the rights
offering will be used to retire debt and for general working capital purposes.
Issuing equity and dilution
• Ownership dilution
• Market value dilution
• Book value dilution: see your accounting textbook
Public vs private long-term debt:
• Private debt has lower floating costs than public: avoids the cost
of OSC registration
• Private debt is likely to have more restrictive covenants
• It is easier to renegotiate a private placement
• Interest rates are higher for private debt (it is more flexible)
Initial Public Offerings
Why do closely held corporations go public?
Pros
•
Facilitates stockholder diversification
•
Increases liquidity
•
Establishes a market value for the firm
•
Greater access to new capital once their shares are valued on the secondary
market
Cons
•
Cost of reporting
•
Disclosure requirements
•
Self-dealings
•
Inactive market/low price
•
Dilution of control
Pricing an IPO: Reality check
I. Initial issue underpricing: in the days following the initial
offering, the price of the stock ends up at a level that is
significantly higher than the offering price;
II. There are cycles in the volume of IPOs and in the extent of
the underpricing;
III. IPO firms underperform in the long run.
IPO underpricing
Possible explanations:
•
The "Winner's curse": There are two types of investors: informed and
uninformed. Informed investors subscribe to the IPO only when they know the
firm has good prospects. If the subscription is not pro-rated informed investors
would always crowd-out uninformed investors. Hence, an uninformed investor
believes that if he/she gets all the shares demanded, it is only because the firm
has poor prospects. Following adverse selection, the firm has to lower the
offering price in order to induce uninformed investors to buy the shares.
•
Lawsuit avoidance
•
Info asymmetry between issuer and investment banker. The banks find it more
convenient to underprice the issue rather than spending time and money in
order to accurately assess the value of the firm.
•
Underpricing signals a company with good prospects
•
The issuer wants to leave a good-taste with investors because in the future the
firm will go back to the capital market for SEO
IPO underpricing
Additional evidence:
• Investment bankers underprice their own IPOs. (When Morgan
Stanley went public in 1986, the managers had promised to hold
on to their shares for two year after the IPO. As a result the price
of the new issue in the secondary market went up dramatically)
• IPOs related positive abnormal returns are positively correlated
to the probability and the size of subsequent SEO.
• Firms that underprice more return more quickly to the capital
market.
• No correlation between underpricing and law-suits outcome.
IPO cycles
Possible explanations:
• Changing risk composition of issuing firms across time
• Firms try to go public during periods when investors are
optimistic
IPO underperformance
• Over 4 years following the IPO, firms that go public have a
worse operating performance than other firms.
• IPO firms in which the managers retains higher ownership
perform better than IPO firms in which management ownership
is lower
• Firms that underprice their IPOs more do not provide superior
long-run operating performance when compared to firms who
underprice their IPOs to a lesser extent
• Operating under-performance of IPOs was worse in the early
80s.
• Under-performance is worse among small and younger firms
Seasoned offerings
• Equity
• Debt
Seasoned offerings: Reality check
Widespread empirical evidence of negative market reaction to
announcement of equity and/or debt offerings:
.

No relation between the estimated profitability of the future investment (if any) and the
market reaction to equity offerings

Common stock issuers enter a significant earnings downturn after they raise capital

Debt issuers raise capital after they had already entered a significant earnings downturn

The amount of capital raised is proportional to the extent of the earnings decline

Forecasts of the current year earnings are on average decreased when firms announce
plans to issue additional common stock

Firms prefer to issue equity after earnings releases

The price drop announcement of equity increases is proportional to the time elapsed since
the last earnings release.

There is a very weak negative market reaction to the announcement of bond issues and
private placements of debt There is a weak positive market reaction to the announcement of
bank loans agreements

Stock price decline is larger for common stock financing than for debt
Stock price reaction: Possible (proposed)
explanations:
•
The market reacts to the dilution of EPS
•
Price pressure
•
The market reacts to changes in the capital structure of the firm
•
Adverse selection:
– signaling changes in the net operating cash flows (debt is a more senior
claim, thus less sensitive to changes in a company's future cash flows)
– signaling management's qualitative assessment of firm's prospects:
decreasing leverage (issuing stock) signals that managers believe the stock
is overpriced (pecking order: retained earnings, debt, preferred stock,
equity)
•
Unanticipated announcements (debt issues could be more predictable)
•
Changes in ownership and control: supported by some evidence (issues that
issues increasing ownership concentration result in a more favorable price
reaction than issues in which ownership concentration is decreased.