This chapter discusses various topics in investment banking including public and private placements. It describes the roles of investment bankers such as underwriting securities, making markets, and advising clients. It also covers the process of distributing securities including setting prices and dealing with dilution. Additionally, it compares public versus private financing and discusses leveraged buyouts. In closing, it briefly touches on going private, methods of doing so, and privatization.

1. Chapter 15
Investment Banking Public and Private
Placements
By
Md. Shahedur Rahaman Chowdhury
15-1

2. Chapter Outline
• What is investment banking?
• Functions of an investment banker
• Dilution of earnings
• Public versus private financing
• Leveraged buyouts and debt for
restructuring of a corporation
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3. The Role of Investment Banking
• The investment banker is the link between
the corporations in need of funds and the
investor
– Responsible for designing and packaging a
security offering
– Responsible for selling the securities to the
public
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4. Concentration of Capital
• Allows large firms to take additional risks
and satisfy the needs of an increasingly
demanding capital market
– Competition has propelled many businesses to
the position they are at now
– Raising capital has become an international
proposition
– Firms that are very large have the ability to
compete
– International consolidations with international
buy-outs of banks have become common
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5. Gramm-Leach-Bliley Act (1999)
• Repealed the separation policy of the
Depression-era laws
– Which included separating banking, brokerage,
insurance, and investment banking into separate
entities
• Federal Reserve and Treasury:
– Have the power to impose restrictions on the
activities of the banks
– Allows strong banks to participate in the venture
capital market
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6. Investment Banking Competitors
• There is intense competition in the market
– Being a leader in one sector helps a firm’s
overall reputation
– It, however, does not ensure success in other
areas
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7. Underwriter
• An investment banker underwrites any risk
associated with a new issue:
– By giving a ‘firm commitment’ to purchase the
securities from the corporation
• Large investment houses assume risk of
distribution
• Smaller investment houses may handle
distributions for unknown corporations
– This is done on a “best efforts” or commission,
basis
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8. Market Maker
• Investment banker engaged in buying and
selling of the security to ensure a liquid
market
– Provides research on the firm to encourage
active investor interest
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9. Advisor
• Services offered include advising the client
on a continuing basis about:
– The types of securities to be sold
– The number of shares or units for distribution
– The timing of the sale
• Important advisory services in the area of
mergers and acquisitions, leveraged
buyouts, and corporate restructuring are
also offered
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10. Agency Functions
• An investment banker may act as an agent
for a corporation
– That wishes to place its securities privately with:
• An insurance company,
• A pension fund, or
• A wealthy individual
– Involves in negotiation of the best possible deal
for the corporation with potential investors
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11. Distribution Process
in Investment Banking
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12. The Spread
• The underwriting spread represents the total
compensation for all participating members
– The lower a party falls in the distribution
process, the higher the price for the shares
– The farther down the line the securities are
resold, the higher the potential profit
– The larger the dollar value of an issue, the
smaller the spread is as a percentage of the
offering price
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13. Allocation of Underwriting Spread
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14. Pricing the Security
• Investment Banker
– Price of the stock is an important consideration
– Conduct an in-depth analysis to determine a
firm’s value:
• The company’s industry
• Financial characteristics
• Anticipated earnings
• Dividend-paying capability
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15. Pricing the Security (cont’d)
• Based on a technique deemed appropriate
by the underwriter:
– A tentative price is assigned
– This will be compared to others in that given
industry
– Anticipated public demand also plays a major
factor
• Underpricing
– Setting the price slightly below the current
market value
• Common during the issuance of additional shares
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16. Dilution
• Problem associated with the issuance of
additional securities:
– Actual or perceived dilution of earnings effect on
shares currently outstanding
– May be caused by the perceived time lag in the
recovery of earning per share
• Resulting from increase in shares outstanding
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17. Market Stabilization
• An investment banker is responsible for
stabilizing the offering during the distribution
period:
– Accomplished by repurchasing securities when
market price is below initial public offering price
– Stabilization lasts for two or three days after
initial offering
– Poor market environment - stabilization may be
very difficult to achieve
– Underwriter price support – an exception to
market manipulation
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18. Aftermarket
• Research shows that the IPO generally
tends to perform well in the immediate
aftermarket
– After the first day of trading, IPO returns are
approximately 3.4% lower than returns for
similar sized firms over the first full year of
trading
– The IPO appears to be a good deal for investors
who purchase shares from the underwriter
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19. Shelf Registration (1982)
• Permits large companies to file one
comprehensive registration statement
– Should outline the firm’s financing plans for up to
2 years
– The firm can issue securities without further
SEC approval
– This registration has become part of the
underwriting process
– Most frequently used with debt issues, and
utilized minimally with the equity markets
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20. Public versus Private Financing
• Many companies, by choice or
circumstance, prefer to remain private
– They restrict their financial activities to direct
dealings
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21. Advantages of Being Public
• To the Corporation:
– Tap security markets for greater amounts of
funds
– Associated prestige – better relationships
– Ability to purchase another firm using its own
stock as currency
• To the Stockholders:
– Ability to achieve a higher degree of liquidity and
to diversify his/her portfolio
– Stockholders of a private corporation can sell
holdings if it decides to go public
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22. Disadvantages of Being Public
• All information must be made public through
SEC and state filings
• Tremendous pressure for short-term
performance by security analysts and large
institutional investors
• For small firms, the underwriting spread and
the out-of-pocket costs can run in the
15-18% range
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23. Public Offerings - Examples
• A classic example of instant wealth – EDS
goes public
• Internet Capital Group
– Refer to the chapter for the complete story
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24. Public Offerings – Examples
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25. Internet Capital Group Price Chart
(as of January 25, 2008)
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26. Private Placement
• Selling of securities not through the security
market but directly:
– Insurance companies
– Pension funds
– Wealthy individuals
• Device is employed by:
– Firms that wish to avoid or defer an IPO offering
– A publicly traded company wishing to merge
private funds into its financing package
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27. Advantages of Private Placement
• No lengthy, expensive registration process
with the SEC
• Firm has greater flexibility in negotiating than
is possible in a public offering
• Initial costs of a private placement may be
considerably lower than those of a public
issue
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28. Disadvantages of Private Placement
• Interest rate on bonds is usually higher to
compensate the investor for holding a less
liquid obligation
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29. Going Private
• The trend:
– 1970s, a number of small firms gave up their
public listings to be private
– 1980s, 1990s, and mid-2000s, very large
companies began going private
• Reason:
– Costs could be saved in annual report
expenses, legal and auditing fees, and security
analysts meetings
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30. Methods of Going Private
• Two ways of going private:
– A publicly owned company is purchased by a
private company or a private equity fund
– To repurchase all publicly traded shares from
stockholders
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31. Leveraged Buyout
• Either the management or some other
investor group borrows the needed cash to
repurchase all the shares of the company
– The company exists with substantial debt and
heavy interest cost
– Management of the private company must sell
assets to reduce the debt load
– Corporate restructuring occurs:
• Divisions and products are sold
• Assets redeployed into new, higher-return areas
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32. Leveraged Buyout (cont’d)
• Investment bankers, as specialists in the
valuation of assets, try to determine the
‘breakup value’ of a large company
– This is its value if all divisions were divided up
and sold separately
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33. Privatization
• Privatization involves:
– Investment bankers taking companies public
– The companies sold have been previously
owned by governments
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34. End
Q
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35. Q&A
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36. Thank You.
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