Minicase:
Novo Industri A/S (Novo)
A case study of how a small Danish
company escaped a small segmented
capital market and internationalized the
cost and availability of capital
Novo, Current Status
• Novo is a Danish multinational firm which
produces industrial enzymes and pharmaceuticals
(mostly insulin).
• In 1977, Novo’s management decided to
“internationalize” its capital structure and sources
of funds.
• As Novo is a technology leader in its specialties,
planned capital investments plant and R&D could
not be postponed until internal financing from
cash flow became available.
2
Novo, Challenges
• Internalization plan was based on the observation
that the Danish securities market was both
illiquid and segmented from other capital
markets (at the time).
• Management realized that the company’s
projected growth opportunities required raising
long-term capital beyond what could be raised
in the domestic market alone.
• In particular, the lack of availability and high cost
of equity capital in Denmark resulted in Novo
having a higher cost of capital than its main
multinational competitors.
3
Novo, Challenges
• Although Novo’s management wished to escape
from the shackles of Denmark’s segmented and
illiquid capital market, many barriers had to be
overcome.
– These barriers included closing the information gap
between the capital markets and the company itself
and executing a share offering in the US (which required
resolving additional barriers imposed by the government
of Denmark on securities issuances).
4
Novo Industri: Case Questions
1.
Why did Novo believe that its cost of capital was
too high compared to its competitors? Why did
Novo’s relatively high cost of capital create a
competitive disadvantage?
– Novo observed that its price/earnings ratio was
only 5 compared to 10 and higher for its
competitors.
– Novo was also told by its bankers that they could
not borrow much more and the domestic equity
market was saturated with respect to Novo’s stock.
– Novo’s high cost and low availability of capital in
Denmark would prevent it from fully exploiting its
competitive advantage in research on insulin and
industrial enzymes.
5
Novo Industri: Case Questions
2. Novo believed that the Danish capital market
was segmented from world capital markets.
Explain the six characteristics of the Danish
equity market that were responsible for its
segmentation.
–
–
–
–
–
–
1) asymmetric information base of Danish and
foreign investors,
2) taxation,
3) alternative sets of feasible portfolios,
4) financial risk,
5) foreign exchange risk, and
6) political risk.
6
Novo Industri: Case Questions
3. What was Novo’s strategy to
internationalize its cost of capital?
–
–
–
–
Novo’s strategy was to increase its level and
the quality of its financial and technical
disclosure in both Danish and English in order
to attract foreign portfolio investors.
Sold a $20 million convertible Eurobond issue in
1978
Listed its shares on the London Stock Exchange
Prepared a prospectus for SEC registration of a
U.S. share offering and eventual listing on the
New York Stock Exchange.
7
Novo Industri: Case Questions
4. What is the evidence that Novo’s
strategy succeeded?
–
–
–
Between April 1980, when its disclosure was
being maximized, and December 1986 Novo’s
stock price increased from Dkr2000 per share
to Dkr600 per share.
Novo’s P/E ratio increased from 5 to 16, which
was then in line with its competitors.
Foreign ownership had increased to over 50%
of Novo’s shares outstanding.
8
Novo Industri: Outcome
• During most of 1981 and the years thereafter
Novo’s share price was driven by
international portfolio investors transacting on
the New York, London, and Copenhagen stock
exchanges.
• This reduced Novo’s weighted average cost of
capital and lowered its marginal cost of capital.
• Novo’s systematic risk was reduced from its
previous level, which was determined by nondiversified (internationally) Danish institutional
investors and the Novo Foundation.
9
Novo Industri: Outcome
• However, its appropriate debt ratio level was also
reduced to match the standards expected by
international portfolio investors trading in the
U.S., U.K., and other important markets.
• In essence, the U.S. dollar became Novo’s
functional currency when being evaluated by
international investors.
– Functional currency: The dominant currency used by a
multinational firm in its day-to-day operation.
• Theoretically, its revised weighted average cost of
capital should have become a new reference
hurdle rate when evaluating new capital
investments in Denmark or abroad.
10
Novo’s B-Share Prices Compared with
Stock Market Indices
11