Ian H. Giddy/NYU
Global Equity Financing-1
Global Equity
Financing
Prof. Ian Giddy
New York University
Corporate Finance
CORPORATE
CORPORATEFINANCE
FINANCE
DECISONS
DECISONS
INVESTMENT
INVESTMENT
FINANCING
FINANCING
PORTFOLIO
RISK
RISKMGT
MGT
MEASUREMENT
CAPITAL
DEBT
M&A
Copyright ©2002 Ian H. Giddy
EQUITY
TOOLS
Global Equity 2
Ian H. Giddy/NYU
Global Equity Financing-2
Corporate Finance
CORPORATE
CORPORATEFINANCE
FINANCE
DECISONS
DECISONS
INVESTMENT
INVESTMENT
FINANCING
FINANCING
PORTFOLIO
RISK
RISKMGT
MGT
MEASUREMENT
CAPITAL
DEBT
EQUITY
TOOLS
M&A
Copyright ©2002 Ian H. Giddy
Global Equity 3
Corporate Finance
CORPORATE
CORPORATEFINANCE
FINANCE
DECISONS
DECISONS
INVESTMENT
INVESTMENT
INVESTMENT
PORTFOLIO
CAPITAL
M&A
Copyright ©2002 Ian H. Giddy
FINANCING
FINANCING
RISK
RISKMGT
MGT
MEASUREMENT
RISK
DEBT
EQUITY
FINANCING
MANAGEMENT
TOOLS
Global Equity 4
Ian H. Giddy/NYU
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
Equity
Debt Capital Markets
Equity Capital Markets
(DCM)
•Syndicate
•Marketing
(ECM)
•Sales
•Trading
•Research
Sales
•Institutional
•Retail
Trading (proprietary)
•Risk
•Profits
Structured Finance
Credit Research
Private Placement
Loan Syndication
Copyright ©2002 Ian H. Giddy
Global Equity 6
Ian H. Giddy/NYU
Global Equity Financing-4
Investment Banking: Organization
New Deal Pitch Team Commitment Committee
l Coverage/
l Investment banking
Investment banking
l ECM/DCM
l Product (DCM or
l Senior sales/trading
ECM)
l Research
Copyright ©2002 Ian H. Giddy
Global Equity 7
Underwriting Sequence
l
l
l
l
l
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
Copyright ©2002 Ian H. Giddy
Engagement
Engagement
Due
Due Diligence
Diligence and
and
Documentation
Documentation
Signing
Signing and
and Pricing
Pricing
Closing
Closing
Global Equity 8
Ian H. Giddy/NYU
Global Equity Financing-5
The Beauty Contest
Criteria for Selecting a Lead Manager 1
l Experience with similar transactions (sector,
market, currency, maturity, high or low-quality
issuers)
l Ranking in League Tables
l Placement power with institutional and/or
retail investors
l 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
l Quality/reputation of research
l Proposed marketing strategy (pricing,
timing, issue size, etc.)
l Proposals for “Roadshow”
l Relationships with potential comanagers
l Senior management commitment to
backing issue with people and capital
Copyright ©2002 Ian H. Giddy
Global Equity 10
Ian H. Giddy/NYU
Global Equity Financing-6
The Roadshow
Organized by global coordinator and
lead managers
l Informal presentation by management
to potential investors
l Attendance limited to professional
intermediaries and investing institutions
l Content must be consistent with
information in draft version of
prospectus or offering circular.
l
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
Copyright ©2002 Ian H. Giddy
Selling Agent
Global Equity 12
Ian H. Giddy/NYU
Global Equity Financing-7
Securities Underwriting: Relationships
Issuer
Agents
Debt: Fiscal agent
Investment Bankers
Lead manager/Bookrunner
Registered offering: Underwriting Agreement
Unregistered: Purchase Agreement
Equity:
Depositary institution
Co- managers
Agreement Among Underwriters
Prospectus/Offering Circular
Institutional Buyers
Copyright ©2002 Ian H. Giddy
Retail Buyers
Global Equity 13
Subscription or Underwriting
Agreement
l
l
l
l
l
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
Ian H. Giddy/NYU
Global Equity Financing-8
What Form of Issue?
Debt
Equity
Domestic
market
Foreign market
(Depositary Receipts)
Asia
Lat Amer
Emerging Markets
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
LOCAL
DEPOSITARY
INSTITUTION
Copyright ©2002 Ian H. Giddy
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.
Non-U.S. issuer gains better
access to U.S. market and
may provide superior
disclosure
INVESTORS
NON-U.S.
ISSUER
Global Equity 16
Ian H. Giddy/NYU
Global Equity Financing-9
Depositary Receipts: Alternatives
Debt
Equity
Domestic
market
Foreign market
(Depositary Receipts)
Unsponsored Private
placement
Private
placement
IPO
Exchange
traded
Global issue
or GDR
Exchange
traded IPO
Copyright ©2002 Ian H. Giddy
Global Equity 17
Equity-Linked Eurobonds
Eurobonds with warrants
l Convertible Eurobonds
l Index-linked Eurobonds
l
Copyright ©2002 Ian H. Giddy
Global Equity 18
Ian H. Giddy/NYU
Global Equity Financing-10
Equity Financing Choices
Convertibles
Warrants
Equity
ADRs
Common
Copyright ©2002 Ian H. Giddy
Global Equity 19
Pricing
Debt Instruments
l
l
l
l
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
Copyright ©2002 Ian H. Giddy
Equity
l
l
Mature issue: based on
current market price and
market conditions, small
premium for dilution;
comparables
IPO: comparables and
discounted cash flow
analysis
Global Equity 20
Ian H. Giddy/NYU
Global Equity Financing-11
Pricing and Fees
The Issuer
The Business
n Telecoms
n Dot-Coms
n Avons
Fees
Pricing
Debt
0.15%
to
1.5%
T+Spread
L+Spread
Equity
5% to
7%
Comparables/Ratios
The market
Future cash flow
valuation
(How much volatility?)
Copyright ©2002 Ian H. Giddy
Global Equity 21
Relative Valuation
l
Do valuation ratios make sense?
• Price/Earnings (P/E) ratios
q and variants (EBIT multiples, EBITDA
multiples, Cash Flow multiples)
• Price/Book (P/BV) ratios
q and variants (Tobin's Q)
• Price/Sales ratios
l
It depends on how they are used -- and
what’s behind them!
Copyright ©2002 Ian H. Giddy
Global Equity 22
Ian H. Giddy/NYU
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)
Present
value of free
cash flows
+ cash,
securities &
excess assets
- Market
value of
debt
Copyright ©2002 Ian H. Giddy
…
Terminal year FCFF
Stable growth model
or P/E comparable
Value of
shareholders
equity
Global Equity 23
Dividend Discount Models:
General Model
∞
Dt
t
t =1 (1 + k )
Vo = ∑
l V0
= Value of Stock
l Dt = Dividend
l k = required return
Copyright ©2002 Ian H. Giddy
Global Equity 24
Ian H. Giddy/NYU
Global Equity Financing-13
Constant Growth Model
Vo =
lg
D o(1 + g )
k −g
= constant perpetual growth rate
Copyright ©2002 Ian H. Giddy
Global Equity 25
Constant Growth Model: Example
nn
D o(1 + g )
Vo =
k −g
nn
nn
nn
Motel
Motel66has
hasearnings
earningsof
of$5
$5
per
share.
It
reinvests
per share. It reinvests40%
40%
and
andpays
paysout
out60%dividend
60%dividend
The
required
return
The required returnthat
that
shareholders
shareholdersexpect
expectis
is15%
15%
The
earnings
are
expected
The earnings are expected
to
togrow
growat
at8%
8%per
perannum
annum
What’s
an
M6
share
What’s an M6 shareworth?
worth?
E1 = $5.00 b = 40%
k = 15%
(1-b) = 60% D1 = $3.00 g = 8%
V0 = 3.00 / (.15 - .08) = $42.86 Plowback
rate
Copyright ©2002 Ian H. Giddy
Global Equity 26
Ian H. Giddy/NYU
Global Equity Financing-14
Shifting Growth Rate Model
(1+ g1)t
DT(1+ g2)
Vo = Do∑
+
t
T
(
1
+
k
)
(
k
−
g
2
)(
1
+
k
)
t=1
T
l g1
= first growth rate
l g 2 = second growth rate
l T = number of periods of growth at
g1
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.
l There is a fully-diversified “market
portfolio” that we should all choose
l 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?
l
Copyright ©2002 Ian H. Giddy
Global Equity 28
Ian H. Giddy/NYU
Global Equity Financing-15
The Weighted Average Cost of Capital
Choice
Cost
1. Equity
Cost of equity
- Retained earnings
- New stock issues
- Warrants
- depends upon riskiness of the stock
- will be affected by level of interest rates
Capital Asset
Pricing Model
(CAPM)
Cost of equity = riskless rate + beta * risk premium
2. Debt
- Bank borrowing
Cost of debt
- 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 =
Capital
Bond Pricing
Cost of capital = Weighted average of cost of equity and
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
rj = RF + βj (rm - RF)
where:
rj
=
RF =
βj
rm
=
=
Required return on asset j;
Risk-free rate of return
Beta Coefficient for asset j;
Market return
The term [β j(rm - RF)] is called the risk premium and
(rm-RF) is called the market risk premium
Copyright ©2002 Ian H. Giddy
Global Equity 30
Ian H. Giddy/NYU
Global Equity Financing-16
International Equity Markets and
Portfolio Diversification
l
l
l
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.
u Establish the riskiness of foreign investment, and the extent
to which combining a foreign with a domestic portfolio
reduces risk.
u Even if it reduces risk, does foreign investment also reduce
expected return?
l
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
TOTAL RISK
P
o
r
t
f
o
l
i
o
DIVERSIFIABLE RISK
R
i
s
k
NONDIVERSIFIABLE RISK
σkp
1
Copyright ©2002 Ian H. Giddy
5
10
15
20
Number of Securities (Assets) in Portfolio
25
Global Equity 32
Ian H. Giddy/NYU
Global Equity Financing-17
The Global Efficient Frontier
AVERAGE RETURN
% PA
30
STOCKS
AND
BONDS
STOCKS
ONLY
25
20
15
EAFE STOCKS
EAFE
STOCKS
& BONDS
10
WORLD STOCKS
WORLD STOCKS & BONDS
US STOCKS
US STOCKS & BONDS
US BONDS
RISK, % PA
5
5
10
15
20
25
30
Copyright ©2002 Ian H. Giddy
Global Equity 33
Returns with FX
l
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
Ian H. Giddy/NYU
Global Equity Financing-18
Returns with FX
(1 + rUS) = (1 + rFM) (1 + rF X)
rUS = return on the foreign investment in
US Dollars
rFM = return on the foreign market in local
currency
rFX = return on the foreign exchange
Copyright ©2002 Ian H. Giddy
Global Equity 35
Example
ROI with FX Change
Local currency ROI
Rate of change of the exchange rate
Foreign currency ROI
17%
-8%
7.64%
Source: giddy.org
Web Resources
Copyright ©2002 Ian H. Giddy
Global Equity 36
Ian H. Giddy/NYU
Global Equity Financing-19
Raising and Pricing
Equity
Prof. Ian Giddy
New York University
Raising Equity:
The Investment Banker’s Job
Market conditions
l Corporate needs
l Valuation
l Information
l Distribution
l
Copyright ©2002 Ian H. Giddy
Telekom
Telekom
Global Equity 38
Ian H. Giddy/NYU
Global Equity Financing-20
Deutsche Telekom: The Sequence
l
See case Exhibit 2
Copyright ©2002 Ian H. Giddy
Global Equity 39
What’s a Company Worth
to Investors?
Required Returns
l Types of Models
l
Telekom
Telekom
uBalance
sheet models
uDividend discount & corporate cash flow
models
uPrice/Earnings ratios
uOption models
l
Estimating Growth Rates
Copyright ©2002 Ian H. Giddy
Global Equity 40
Ian H. Giddy/NYU
Global Equity Financing-21
Equity Valuation:
From the Balance Sheet
Value of Assets
n Book
n Liquidation
n Replacement
Value of
Liabilities
n Book
n Market
Value of Equity
Copyright ©2002 Ian H. Giddy
Global Equity 41
Deutsche Telekom: Book Value
l
See case Exhibit 3
Copyright ©2002 Ian H. Giddy
Global Equity 42
Ian H. Giddy/NYU
Global Equity Financing-22
Relative Valuation
l
Do valuation ratios make sense?
• Price/Earnings (P/E) ratios
q and variants (EBIT multiples, EBITDA
multiples, Cash Flow multiples)
• Price/Book (P/BV) ratios
q and variants (Tobin's Q)
• Price/Sales ratios
l
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
l
See case page 9
Copyright ©2002 Ian H. Giddy
Global Equity 44
Ian H. Giddy/NYU
Global Equity Financing-23
Discounted Cashflow Valuation:
Basis for Approach
t =n CF
t
Value= ∑
t
(1+r)
t =1
uwhere
n = Life of the asset
u CFt = Cashflow in period t
u r = Discount rate reflecting the riskiness of
the estimated cashflows
u
Copyright ©2002 Ian H. Giddy
Global Equity 45
Deutsche Telekom: Earnings
l
See case page 8
Copyright ©2002 Ian H. Giddy
Global Equity 46
Ian H. Giddy/NYU
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)
Present
value of free
cash flows
+ cash,
securities &
excess assets
- Market
value of
debt
Copyright ©2002 Ian H. Giddy
…
Terminal year FCFF
Stable growth model
or P/E comparable
Value of
shareholders
equity
Global Equity 47
What’s a Company Worth?
Alternative Models
l
The options approach
uOption to expand
uOption
l
Lycos
Lycos
to abandon
Creation of key resources that another
company would pay for
uPatents
or trademarks
uTeams of employees
uCustomers
l
Messageclick.com
Messageclick.com
Examples?
Copyright ©2002 Ian H. Giddy
Global Equity 48
Ian H. Giddy/NYU
Global Equity Financing-25
Raising Equity:
The Investment Banker’s Job
Market conditions
l Corporate needs
l Valuation
l Information
l Distribution
l
Copyright ©2002 Ian H. Giddy
Telekom
Telekom
T-Online
T-Online
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