FINS1613 Lecture Notes - Lecture 11: Seasoned Equity Offering, Government Debt, Investment Banking

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22 Jul 2018

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Raising equity: firms typically initially raise capital by selling equity to private investors, venture capitalists: professional investors who focus almost exclusively on purchasing shares in young firms. Institutional investors: invest in nearly all types of assets. Will invest in higher risk new firms as a way to get higher returns: corporate investors: may invest in firms in related industries as part of strategic initiative. Ipos are generally under-priced, leading to an increase in price on the first day. Shares generally underperform the market 3 to 5 years from the ipo: an ipo"s success does not exclusively depend on the firm"s outlook: Investors prefer ipos at some times and prefer other source of capital at others. Even good firms may not have a successful ipo if the market is unreceptive: a seasoned equity offering (seo) occurs when a publicly traded firm sells additional shares.

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The company's entire equity capital of 1.5 million shares was owned by teo founders and Ms Sloberg. The intial public offering involved the sale of 500,000 shares by the three existing shareholders, together with the sale of further 750,000 shares by the company in order to provide funds for expansion.

The company estimated that the issue would involve legal fees, auditing, printing, and other expenses of $1.3 million, which would be shared proportionately between selling shareholders and the company. In addition, the company agreed to pay the underwriters a spread of $1.25 per share (this cost would also be shared).

The roadshow had confirmed the high level of interest in the issue, and indications from investors suggested that the entire issue could be sold at a price of $24 a share. The underwriters, however, cautioned about being too greedy on price. They pointed oot that indications from investors were not the same as firm orders. Also, they argued, it was much more important to have a successful issue than have a group of disgrunted shareholders. They therefore suggested an issue price of $18 a share.

That evening Mutt.com's financial manager decided to run through some calculations. First, she worked out the net receipts to the company and the exsisting shareholders assuming the stock was sold at $18 per share. Next, she looked at the various costs of the IPO and tried to judge how they stacked up against the question of underpricing. When she had raised the matter with the underwritters that morning, they had dismissed the notion that the initial day's return on an IPO should be considered part of the issue costs. One of the members of the underwriting team asked: "the underwritiers want to see a high return and a high stock price. "Would Mutt.Com prefer a low stock price? Would that make the issue less costly?" Mutt.Com's financial manager was not convinced but felt that she should have a good answer. She wondered wheather unerpricing was only a problem because the exsisting shareholders were selling part of their holdings. Perhaps the issue price would not matter if they had not planned to sell.

erinskunk64

Mutt.com was founded in 2006 by two graduates of the University of Wisconsin with the help from Georgina Sloberg, who had built up an enviable reputation for backing new start-up businesses. Mutt.com's user-friendly system was designed to find buyers for unwanted pets. Within 3 years the company was generating revenues of $3.4 million a year and, despite racking up sizeable losses, was regarded by investors as one of the hottest new e-commerce businesses. The news that the company was preparing to go public therefore generated considerable excitement. The company's entire equity capital of 1.5 million shares was owned by teo founders and Ms Sloberg. The intial public offering involved the sale of 500,000 shares by the three existing shareholders, together with the sale of further 750,000 shares by the company in order to provide funds for expansion. The company estimated that the issue would involve legal fees, auditing, printing, and other expenses of $1.3 million, which would be shared proportionately between selling shareholders and the company. In addition, the company agreed to pay the underwriters a spread of $1.25 per share (this cost would also be shared). The roadshow had confirmed the high level of interest in the issue, and indications from investors suggested that the entire issue could be sold at a price of $24 a share. The underwriters, however, cautioned about being too greedy on price. They pointed oot that indications from investors were not the same as firm orders. Also, they argued, it was much more important to have a successful issue than have a group of disgrunted shareholders. They therefore suggested an issue price of $18 a share. That evening Mutt.com's financial manager decided to run through some calculations. First, she worked out the net receipts to the company and the exsisting shareholders assuming the stock was sold at $18 per share. Next, she looked at the various costs of the IPO and tried to judge how they stacked up against the question of underpricing. When she had raised the matter with the underwritters that morning, they had dismissed the notion that the initial day's return on an IPO should be considered part of the issue costs. One of the members of the underwriting team asked: "the underwritiers want to see a high return and a high stock price. "Would Mutt.Com prefer a low stock price? Would that make the issue less costly?" Mutt.Com's financial manager was not convinced but felt that she should have a good answer. She wondered wheather unerpricing was only a problem because the exsisting shareholders were selling part of their holdings. Perhaps the issue price would not matter if they had not planned to sell.

Please answer the following questions after reading the attached MiniCase: 1. Calculate all flotation (issue) costs of IPO for Mutt.Com 2. Calculate the three ratios (Direct Cost Ratio: Direct Costs/Funds Raised) and (Indirect Cost Ratio: Underpricing Costs/Funds Raised). Compare these two ratios to the numbers in Figure 15.3 and Figure 15.5 in Chapter 15. 3. Calculate the spread cost ratio (Spread Cost Ratio: Total Spread Cost/Funds Raised). Compare this ratio to the numbers in Table 15.3 in Chapter 15. 4. Calculate another ratio known as total flotation cost ratio (Total flotation costs/Value of Shares issued). Please note that the value of shares issued is based on the non-underpriced value of the issue. Do you think that issuing equity is a cheap process? Use your answer to justify your opinion. 5. Answer the following questions in the MiniCase focusing on whether underpricing should be considered as a part of total flotation cost: a. Would Mutt.Com prefer a low stock price? b. Would that make the issue less costly?

ochresnake128

International Research Journal of Applied Finance ISSN 2229 â 6891

Vol. VI Issue â 8 August, 2015 Case Study Series

A Stock Valuation Case: An Application of the âMethod of Comparablesâ for Macyâs Shares

Halil D. Kaya* ,Julia S. Kwok

Abstract

The primary focus of this case is the application of the âMethod of Comparablesâ in the estimation of the value of a security. An investment decision will be made based on the comparison of the selling price and the estimated value. A security will be good for purchase if the estimated value is higher than the market price. This method utilizes basic financial ratios that are commonly provided by financial web sites. First, using Yahoo Finance website, the pricing, sales, book value of equity and shares outstanding data are collected for both the target firm and the competitor firms. Then, the pricing multiples (i.e. price earnings ratio, price to sales ratio and price to book ratio) of the competitors are calculated. After that, those multiples along with the target firmâs earnings, sales, book value and shares outstanding data are used to estimate target firmâs share value. The case also examines the impact of treating ânegativesâ in the data. Students will learn that replacing negative earnings with zeros tend to induce less bias in target firmâs value estimation than excluding the ânegativeâ data altogether.

Introduction

March 14, 2015 was a sunny day. Mary took advantage of the nice weather to have lunch at the Mall. On her way back to work, she walked by Susanâs investment office. Susan was Maryâs college roommate. They both liked shopping together to find new fashionable clothes. Looking at her watch, Mary realized she had half an hour to spend. She thought she would drop by and say hello to Susan.

The Performance of Macyâs

âHi, Susan, how are you?â How is your business?â said Mary. Susan was a recent finance graduate. Susan replied, âI am doing fine. Thank you. After so many years, the market is still recovering from the mortgage crisis; many investors have been buying back stocks that they have sold during the crisis. What are you up to?â âI want to start my investment in securities, too. I have a couple thousand dollars, would Macyâs be a good stock to invest in now? That was our favorite store to shop among all of the department stores,â Mary exclaimed. She added, âAlso, I read from Motleyâs Foolâs article on Macyâs today about its earnings per share growth for the last 16 quartersâ (Zahid Waheed, 2014).

In response to Maryâs questions, Susan checked the monthly adjusted returns of Macyâs in Yahoo Finance. She found that, since March 2010, Macyâs stock price had an average annual increase of 23.5% over the last 5 years. The stock rose from $19.98 to $57.38. Susan then told Mary that Macyâs was indeed a growing stock. She added that its success could be attributed to the omni-channel integration, e-commerce and magic selling strategies which allowed merging of sales channels, online shopping and better customer care. Since investment strategy 101 is to buy low, and sell high, given Macyâs stock price had been going up, Susan was not sure whether Macyâs was currently overvalued or undervalued by the market.

The Method of Comparables

Susan remembered her class lecture on the two types of valuation of stocks, namely absolute and relative evaluation. The absolute evaluation focuses on finding the intrinsic value of the security based on fundamentals. That involves more complicated models of discounting cash flows from dividends, operations and residual income.

On the other hand, relative evaluation is quick and easy to use. It assumes two similar securities should sell for one price in an efficient market, i.e. âLaw of One Price.â So an analyst can estimate its stock price by multiplying target companyâs specific earnings, sales and equity value data by the earning, sales and equity âper shareâ financial multiples of its competitors.

Since Mary was not familiarized with financial models, Susan decided to use the easy-toperform-and-analyze âComparables Methodâ to estimate the relative value of Macyâs stock.

The Financial Data

Dillards, JC Penney and Nordstrom were selected as competitors of Macyâs as they were all in retail department store business. Susan would need some financial data regarding these companies. She went to SECâs (i.e. Securities and Exchange Commission) website and downloaded these companiesâ most recent balance sheet and income statement data. Out of those statements, she knew that she would need the EPS (i.e. earnings per share), the sales number, the number of outstanding shares, and the book value of equity. She also knew that she would need the current share price for each company. After some work, she had found all the necessary information to run the analysis. Below were the data that she had gathered:

All data are in US$ except for the number of outstanding shares. The share price as of March 15, 2014 is shown in the first column. The âEarnings per shareâ is shown in the second column. The third column reports the book value of equity. The last column shows the number of outstanding shares.

Firm	P ($)	EPS ($)	Sales ($)	BV of equity ($)	# of shares
Macy's	58.58	3.93	27,931 mil.	6,249 mil.	378.3 mil.
Dillard's	90.61	7.10	6,532 mil.	1,992 mil.	45.6 mil.
JC Penney	8.71	-5.57	11,859 mil.	3,087 mil.	249.3 mil.
Nordstrom	61.33	3.77	12,166 mil.	2,080 mil.	194.5 mil.

The Decision

Susan thinks that the following steps would be necessary to perform the analysis:

1.Based on the data above, calculate Sales per share, BV of equity/share values of all firms. Note that EPS is directly given.

2.Calculate P/E, P/Sales, and P/B for all of Macyâs competitors based on the data obtained.

3.Find the average of the P/E, P/Sales, and P/B multiples for the three competitors.

4.Multiply those averages calculated in step 3 with Macyâs EPS, Sales per share, and BV of equity/share values, respectively to get three value estimates for Macyâs shares.

5.The average of the three estimates would then be Susanâs best estimate of Macyâs value per share.

answer # 1-5 please

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FINS1613 Lecture Notes - Lecture 11: Seasoned Equity Offering, Government Debt, Investment Banking

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