Copyright 2004 McGraw-Hill Australia Issuing Securities to the Public • Analyse funding needs and how they can be met.. Copyright 2004 McGraw-Hill Australia Issuing Securities to the
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17.1 The Public Issue
17.2 The Cash Offer
17.3 New Equity Sales and the Value of the Firm
17.4 The Costs of Issuing Securities
17.5 Rights
17.6 Dilution
17.7 Issuing Long-term Debt
17.8 Summary and Conclusions
Chapter Organisation
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• Discuss the process of underwriting and the associated costs.
• Identify the costs associated with issuing securities.
• Explain the process of a rights issue and calculate the value
of a right.
• Discuss the dilution effect of new issues.
• Understand the reasons for recent growth in the corporate debt market.
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Issuing Securities to the Public
• Analyse funding needs and how they can be met
• Approval from board of directors for a public issue
• Outside expert opinions sought for support of
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Issuing Securities to the Public
• Underwriting agreement executed
• Prospectus registered
• Public announcement of offering
• Funds received
• Shares allotted, holdings registered
• Shares listed for trading on ASX
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• Primary issues used to:
– convert from a private company to a public company
– spin-off a portion of the business of a listed company
– form a new public company
– privatise a public organisation, or demutualise a mutual society.
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• Access to additional capital.
• Increased negotiability of capital.
• Growth not limited by cash resources.
• Enhancement of corporate image.
• Can attract and retain key personnel.
• Gain independence from a spin-off.
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• Dilution of control of existing owners.
• Additional responsibilities of directors.
• Greater disclosure of information.
• Explicit costs.
• Insider trading implications.
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• Private placements—securities are offered and sold to a
limited number of investors who are often the current major investors in the business.
• Rights issues—issue of shares made to all existing
shareholders, who are entitled to take up the new shares in proportion to their present holdings
• Terms are determined by:
– amount of funds required by the company
– the market price of the company’s securities
– general economic conditions
– desire to benefit shareholders
– nature of the company’s shareholders.
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A guarantee that funds will be made available to a company
at a specific time on agreed terms and conditions.
• Standby underwriting
Where the bidding company has insufficient cash in a successful bid or if cash is offered as an alternative to a share bid.
• Best efforts underwriting
Underwriter must use ‘best efforts’ to sell the securities at the agreed offering rate.
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– pricing the issue
– marketing the issue
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• The underwriter’s fee is a reflection of the:
– size of the issue
– issue price
– general market conditions
– market attitude towards shares
– time period required for underwriting.
• Fees also include brokerage and management fees.
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Average Initial Returns
Source: Ibbotson, Sindelar and Ritter (1988)
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– Excessive debt usage.
– Substantial issue costs.
– Management needs to understand the signals that an equity issue sends.
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Issue of ordinary shares to existing shareholders.
• Allows current shareholders to avoid the dilution that can occur with a new share issue.
• ‘Rights’ are given to the shareholders specifying:
– number of shares that can be purchased
– purchase price
– time frame.
• Shareholders can either exercise their rights or sell them They neither win nor lose either way.
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of the right.
• Holder-of-record date
Date on which existing shareholders are designated as the recipients of share rights.
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S
M n
offered shares
additional of
number
issue rights
the of
price issue
or
on subscripti
price market
right a
obtain to
held shares
of number
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$6 million To raise the finance, the company makes a rights issue at a subscription price of $6 per share
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• The number of new shares to be sold:
• The holder of one right is entitled to subscribe to one new share at $6 per share.
• To issue 1 million shares, the company would have to issue
1 million rights.
• The company has 5 million shares on issue, which means that for every 5 shares held, a shareholder is entitled to receive one right (1-for-5 rights issue).
shares 000
000 1
$6
000 000
$6
price
on subscripti
raised be
to funds
=
=
=
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• Calculate the theoretical rights price:
• If an outsider buys a right, it will cost $1.67.
• The right can be exercised at a subscription price of $6.
• Total cost of a new share = $1.67 + $6 = $7.67.
$1.67
15
$6
$85
S M
n
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– Dilution of proportionate ownership—a shareholder’s
reduction in proportionate ownership due to proportionate purchase of new shares.
less-than-– Dilution of market value—loss in share value due to use
of proceeds to invest in negative NPV projects.
– Dilution of book value and earnings per share (EPS) —
reduction in EPS due to sale of additional shares This has no economic consequences.
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– the fall in interest rates from extremely high levels
– the flight to quality
– the shortage of government bonds
– the attractiveness of raising funds in the domestic market relative to that of the euromarket.
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– direct loans avoid ASIC registration costs
– direct loans have more restrictive covenants
– term loans and private placements are easier to renegotiate than public issues
– private placements are dominated by life insurance companies and pension funds, whereas commercial banks dominate the term-loan market.