IPO Process

Promote the company and explain the rationale for an offer price to the largest customers (mainly institutional investors) Allows to gather information about potential purchasers.

4. Present Road-Show

-After the registration statement is approved by SEC the offer price and number of shares to be sold has to be determined. -The securities are priced base on the value of the company and the expected demand. Valuation methods: NPV, E/P

5. Price The Securities

- A complete selling effort gets under way on the effective date of the registration statement. - A final prospectus must accompany the delivery of the securities.

6. Sell The Securities

In a seasoned issue of stock, the price drops by 3% on average on the announcement of the issue.

Abnormal Returns

-Access to capital Markets. -Improved liquidity for shareholders. -Allow original owners to diversify. -Monitoring by external capital markets. -Information provided by capital markets. - Enhanced credibility with stakeholders.

Advantages of IPO

- There are informed investors (know the true value of the stock) and uninformed investors (invest randomly without knowing the company). - The investment bank has perfect knowledge of the real value of the issuer and the issuer must rely and the bank's audit for this information. - The price fluctuates by changes in demand for the stock. (demand of informed and demand of uninformed investors).

Adverse Selection Theory

- Primary shares - Secondary shares - Tombstone: Newspaper ad where an underwriter advertises a security issuance.

Mechanics of an SEO

when a public company offers new shares for sale. To raise additional equity. Follow many of the same steps as an IPO. The main difference is that a market price already exists so the price setting process is not necessary.

Seasoned Equity Offering (SEO)

- Underpricing is a signal that the company is of high quality. - The owner of a company has a motive to leave a good impression since they may return to the market later on to sell stock at more attractive terms and raise more capital.

Signaling Models

Direct fees paid by the issuer to the underwriting. Difference between the price the issuer receives and the offer price.

Spread

- An underwriter is an investment firm that acts as an intermidiary between a company selling securities and the investing public. - Typically, the underwriter buys the securities for less than the offering price and accepts the risk of not being able to sell them. - Underwriters combine to form an underwriting group called a syndicate or banking group to share the risk. - The difference between the underwriter's buying price and the offering price is the spread or discount.

1. Select an underwriter

The firm must prepare a registration statement and file it with the SEC. The statement discloses all material information concerning the corporation making a public offering.

2. Register IPO with SEC

A prospectus is a legal document describing details of the issuing corporation and the proposed offering to potential investors.

3. Print Prospectus

The underwriter is legally bound to use best efforts to sell the securities at the agreed upon price.

Best Efforts Underwriting

The issuer sells the entire issue to one investment dealer that then attempts to sell it. The dealer assumes all the price risk.

Bought Deal

-Expensive -Costs of dealing with shareholders - Allowing competitors gain information - Public pressure

Disadvantages of IPO

Regular underwriting minus the out clause.

Firm Commitment Underwriting

1. Select an underwriter 2. Register IPO with the SEC 3. Print Prospectus 4. Present roadshow 5. Price the securities 6. Sell the securities

IPO Process

Cost not reported on the prospectus and include the costs of management and time spent working on the new issue.

Indirect Expenses

Direct costs, incurred by the issuer, that are not part of the compensation to underwriters. Filing fees, legal fees and taxes. all reported on the prospectus.

Other direct Expenses

When the price of the new issue is too low, it is often oversubscribed and investors won't be able to buy all the share they want. Underwriters will have to allocate the shares among the investors.

Oversubscription

Firms do not set the price in an arbitrary way. When the aim of the IPO is to encourage retail investors to participate in the subscription, the issuers set relatively low prices to encourage potential small investors.

Possible explanation for underpricing

- The price of the IPO must be low enough to induce the investment bank to act in the best interest of the issuer.

Principle Agent Theory

The banking group buys the securities from the firm and resells them to the public for the purchase price plus a spread. Includes an out clause which gives the banking group the option to decline the issue if the price drops dramatically (the deal is usually withdrawn, the issue could be repriced, reoffered later)

Regular Underwriting

1. Spread 2. Other direct expenses 3. Indirect expenses 4. Abnormal returns 5. Underpricing

The costs of Issuing Securities

Regular Underwriting Bought Deal

Types of Underwriting

For IPOs, losses arise from selling the stock below the correct value.

Underpricing

The pricing of the IPO is below its market value. Usually it is underpriced temporarily because the laws of supply and demand will drive it to its intrinsic value.

Underpricing