L8_L9_SEOs

2.2 Seasoned offerings (SEOs) ................................................................................................................................ 2 

2.2.1 BRIEF OVERVIEW OF SEOS ............................................................................................................................... 2 

2.2.2 DIFFERENT ALTERNATIVES AROUND THE WORLD FOR THE INCREASING OF CAPITAL ........................................ 2 

Conclusions ............................................................................................................................................................ 4 

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1.2 Seasoned offerings (SEOs)

1.2.1 BRIEF OVERVIEW OF SEOS

A firm can raise funds either internally or externally. If a company prefers to use internal funds it will have
to refer to retained earnings, while if it prefers external funds it can decide either to choose new debt (using
syndicated loans or corporate bonds) or new equity. Raising funds through equity is the last option available
to companies, especially for public companies, because equity is more expensive with respect to the other
two alternatives. Then why a corporation should opt for a SEO? The reason is straightforward: the company
is probably already highly levered and cannot ask for new debt and do not generate sufficient earnings.
Therefore, the only possibility still open to raising funds, to restructure debt or support investments, is
through a capital increase. Pay attention that public companies cannot use funds raised through SEOs for
paying dividends. Taking into consideration the argument just made is very intuitive to understand why a
SEO is a bad signal to the market. If a firm cannot raise more debt or does not have enough earnings, both
are signals of financial or operating difficulties, which in other words means bad management. The result of
the announcement of a SEO is a decrease in the stock price, no matter what the reasons are.
Notwithstanding the fact that SEOs are much less difficult to carry out with respect to IPOs, because of
fewer information asymmetries, still, the role of investment banks is crucial for the success or failure of this
transaction. They need to present it in a very appealing way, given that the market already interprets it in a
bad fashion.
Whether we are analysing an SEO in the Unites States or in Europe in both cases there is the possibility of
dilution effect. When additional shares are issued the investors’ proportional ownership in the company is
reduced. In other words, when the number of outstanding shares increases each existing shareholder owns a
smaller percentage of the company making each share less valuable. Dilution also reduces the value of
existing shares by reducing the stock earnings per share. The potential benefit from a decrease in EPS is that
the funds the company receives from the sale of new shares can boost the company’s profitability and stock
value.
A further distinction which is worth mentioning is the different in the approaches we encounter in U.S. with
respect to the European market. The main difference is that a European company must ask to its pre-existing
shareholders if they are willing to subscribe the capital increase and therefore participate to the issuing or
not. The main reason for the subscription of the SEO is to prevent existing shareholders to be diluted due to
the issuing of new shares. This method is longer than the alternatives available in the U.S; it lasts a minimum
amount of time of two months to raise funds from pre-existing shareholders.
The American strategies give the possibility to close the transaction in two days since there is no obligation
to ask to existing shareholders if they are willing to participate or not.
Because of the importance of raising funds, to conduct the strategy each corporation needs, it is common
practice for public companies to ask for the advisory of investment banks. The role of these financial
institutions is to assist the client in raising funds. There is substantial difference in the role investment banks
have in seasoned equity offerings or IPOs. An IPO is much more difficult to be conducted, therefore requires
more effort from the investment bank which translates into more fees to be paid to the bank. Once the
company is public it needs less assistance to raise new funds. In this case IBs are called to ensure soundness
to the transaction and to identify the right target of investors which are willing to buy the shares.

1.2.2 DIFFERENT ALTERNATIVES AROUND THE WORLD FOR THE INCREASING OF CAPITAL

There are three different alternatives that can be applied by a corporation to raise capital. Two of these
alternatives (bought deals and accelerated book building) are available for US listed companies and the last
one (right issue) applies to European listed companies.
In Bought Deals we have the involvement of an IB that buys shares from the issuer and after that sells the
shares as quickly as possible to institutional investors. The IB buys the shares because it knows that it's going
to be able to resell them in a few days. The IB takes the risk to buy at a certain price to hopefully resell at a
higher price.
.

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The risk for the IB is to buy the issue without knowing exactly if there are enough institutional investors
willing to pay a higher price.
Accelerated Book Building (ABB) are those transactions which occur in a very short period of time. In
order to implement a traditional one during an IPO, you need minimum of a couple of weeks. However, if a
company is already listed and wants to use an ABB, the process is likely to take only a couple of days. This
is achieved through targeting a small group of institutional investors in order to implement a fast book
building procedure to sell/allocate all the shares of the company sold in the SEO. Profits are represented by
the gross spread amount of Fees paid to the advisor .
In both mechanisms (BO and ABB), it is possible to reach only institutional investors because of the time
constrain and because of the amount of risk that cannot be absorbed by retail investors.
Meanwhile in US and Canada companies are authorized to sell additional shares in a matter of a few days
implementing these two strategies to increase the capital of the company, in Europe it is necessary to go with
the so-called "Right Issue" procedure.
Right Issue: there is the right given to pre-existing shareholders to be offered to participate before than
others to the SEOs (increase of capital). This right comes from the Napoleon Code and makes the process
very long, and usually lasts between 3 and 6 months. On the day of the launch, shareholders receive are
offered to participate to the seasoned offering. In proportion with the number of shares held by pre-existing
shareholders before the increase of capital, it is given to them the right to buy new shares in order to maintain
their participation in the company. During the meeting with shareholders, the issuer with the support of the
advisor offer them a discounted price at which they can participate at the increase of capital the they of the
execution in the Market that usually happens within 2 months from the shareholder meeting.
The market doesn't react ever well when there is the announcement of an increase of capital because in the
end this means that the company is asking for money that is unable to raise on its own asking for debt loans
and that also does not have enough profits available to cover the issue. In other words, the market
understands that there is a problem in the way in which the company is carried out. In fact, usually the
launch of an increase of capital is necessary because of growth that cannot be sustained with available
resources (earnings) or because there is the necessity of implementing restructuring strategies.
Another reason of the bad reaction of the market can be explained with the fact that the participation to the
increase of capital is necessary for shareholders if they do not want to be diluted after the issue in the case in
which the new capital is bought by new investors.

Example: Assume that the total number of shares of a firm before an increase of capital is 100. If the firm
sells another 100 shares, the total number of shares outstanding after the transaction would be 200. In this
case, if an investor is holding 5 shares (5%) out of the 100 shares before the capital increase, he/she decides
to not participate to the transaction, after all he/she will still have 5 shares out of an outstanding number of
200 shares that now represents only 2.5% of the equity.
In Europe, dilution is prevented by offering to pre-existing shareholders the possibility to buy the number of
shares that is necessary to them to maintain the same ownership after the increase of capital. The transaction
has to be approved with the favourable vote of pre-existing shareholders to whom must be given the chance
to maintain the same share of equity after the completion of the process.
The incentive to participate to the transaction is given by offering to pre-existing shareholders an American1
option that lasts three weeks from the day of the execution in to the market. The option gives the possibility
to exercise a strike price that hopefully is going to be below the expected (theoretically) traded prices during
the three weeks of execution.
The value of 1 share post-issue is going to be the average of the value of the old and new shares and it is
called TERP = Theoretical Ex-Right Price

n number of outstanding shares
P current market price
                                                            
1
 European options: the holder has a specific day in the future in which is authorized to exercise the option. American 
options are when the holder has a time period to exercise the option.  
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 N number of newly issued shares
S issue price

Because the day of the execution in the market the old share butterflies itself in two different instruments, it
is possible to calculate the value of one right as the difference between the market price (before the
execution) and the price of the share ex-right:

The TERP is called and referred to as theoretical because, when we have the EGM (Extraordinary General
Meeting) with shareholders we are in advance of at least two months with the day when the execution will
happen in the market. During the EGM has to be offered an option to pre-existing shareholders that has to be
then in the money two months later. An option is in the money if the strike price is below the current market
price. This means that during the EGM we have to offer a discount to the Market Price at which shares will
be traded during the execution of the transaction. Therefore, it is called theoretical because it is just a
prediction the day of the shareholder meeting and it is called ex-right because at the time of the execution
shares will be traded separately from the value of the right. The issue price, in order for the option to be in
the money, has to be given at a discount from the TERP. Different types of discounts in ECM are Discount
to Peers, Discount to Terp and Discount to Market. The first one, discount to peers, is applied the day before
we go public. This is when we must tell the entrepreneur that we have to sell at a discount to peers, to give
investors a reason to support the price of the shares the day of the IPO and after. This is because the investors
know that even if the price partially drops, the value of what they bought is high, so they are not going to
sell. The discount to TERP is the second discount that we find in ECM. During the EGM, we must set a price
that is below the current market price the day of the SEO. We must predict the current market price at the
time of the issue, which is TERP. The discounted price is the discount to TERP. So, your shareholders will
have in their hands an option that is in the money.
If the price of the shares once the issue is made goes below the TERP and the option is above the current
market price, it's bad because shareholders won't exercise the right. In this case, the value of the right
becomes 0. The issuer is going to sell 0 shares to pre-existing shareholders and all unsold rights are called
RUMP.
d

Rump is the number of new shares unsold. The company wants to avoid this risk usually offering a full
underwriting mandate to the advisor. This means that the advisor is committed to buy all the rump at the
strike price offered to shareholders even though the option is out of the money. This is the big risk of these
transactions and this is why fees requested by advisors are so high also for these capital markets transactions.

Conclusions
This chapter has covered the Equity Capital Markets and the two main ways to raise capital using ECM. The
most popular use of ECM are the Initial Public Offerings. An IPO is the very first time a firm publicly lists
itself in a stock market. It is very common to find big celebrations and news channels surrounding the stock
markets, such as the NYSE, during the day of an IPO. These events are watched all around the globe and are
the centre of economic attention of the day that they take place. This is because firms raise considerable
amount of capital on the IPO day and these occasions represent an important opportunity to investors from
all around the globe. According to the New York Stock Exchange: “IPOs are a proven method of connecting
companies, employees and economies with the capital they need to expand their businesses, build more jobs
in their communities, retain top employees and elevate their brands. It’s a process that fuels innovation,
drives growth and encourages healthy competition.”
Another key use of ECM are Seasoned Offerings. Usually on an IPO, the firms don’t sell 100% of their
equity, but only a certain part of it. During an SEO, the firms sell an additional portion of their equity to raise
extra capital.
In order to have a better understanding how IPOs and SEOs apply to the financial world, here’s how
Goldman Sachs defines their ECM activity: “The Equity Capital Markets team works closely with public and
private companies, governments and financial sponsors to originate, structure and execute equity and equity-

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linked financings such as initial public offerings, follow on offerings, convertibles and derivatives”. As you
can see, initial public offerings and seasoned offerings (follow-on-offerings), are integral parts of what
investments bankers work on, on a daily basis.
On NYSE’s IPO Guide, J.P. Morgan lists the advantages and potential issues of conducting an IPO in the
following way:

– Access to capital: The most common reasons for going public are to raise primary capital to
provide the company with working capital to fund organic growth, to repay debt or to fund
acquisitions. Following the IPO, the company will be able to tap the equity markets via follow
on offerings of primary and/ or secondary shares, or a mix thereof. After the company has been
public for one year, it will be eligible to access the equity capital markets on demand via a shelf
registration statement.
– Liquidity event: The IPO can be structured such that existing owners of the company can sell
down their position and receive proceeds for their shares. In addition, once the company is
public, the existing owners have a public marketplace through which they can monetize their
holdings in a straightforward and orderly fashion.
– Branding event and prestige: By listing on the NYSE, the company will receive worldwide
media coverage through the financial markets, which provide constant live coverage on publicly
traded companies.
– Public currency for acquisitions: Once the company is public, it can use its publicly tradable
common stock in whole or in part to acquire other public or private companies in conjunction
with, or instead of, raising additional capital.
– Enhanced benefits for current employees: Stock-based compensation incentives align
employees’ interests with those of the company. By allowing employees to benefit alongside the
company’s financial success, these programs increase productivity and loyalty to the company
and serve as a key selling mechanism when attracting top talent.
– Loss of privacy and flexibility: In order to comply with securities laws, public companies must
disclose various forms of potentially sensitive information publicly, which regulatory agencies,
as well as competitors, can then access.
– Regulatory requirements and potential liability: Correspondingly, public companies must
regularly file various reports with the Securities and Exchange Commission (SEC) and other
regulators.
– Cost and distraction of management time and attention: Going public is a relatively expensive
process, incurring one-off and ongoing costs for legal counsel, accounting and auditing services,
D&O insurance, underwriting fees, printing, as well as for additional personnel to handle
expanded reporting, compliance, and investor relations activities.
 
With the advent of social media, financial firms started to share their daily activity with their followers. A
great way to keep up to date with NYSE IPOs for example, is to follow their Instagram feed where they
publish all their day-to-day activity and interviews in which they explain the mechanics behind ECM

Additional info and reading material:

– https://www.nyse.com/ipo-center/filings
– https://www.londonstockexchange.com/companies-and-advisors/main-market/main-
market/home.htm
– https://www.borsaitaliana.it/borsa/azioni/ipo/tutte-le-ipo.html?lang=en
 
To summarize the main concepts covered we can say that the focus was on public companies. We said that in
the Public Equity sector, a firm can either execute an IPO or SEO and an SEO can be conducted in either an
American or a European way. In the Private Equity sector, we mentioned that institutional investors are PE
investors and retail investors deal with private placements. We listed the main reasons for an IPO as
Financial, Strategic and Governance reasons.
In the IPO process, we learned that we need to answer the following questions in order to understand the
issuing structure Where to sell the shares; in which market to sell; Which shares to sell; To whom to sell.

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We learned that key steps of an IPO are Preparation, Pre-launch, Execution.
We mentioned important concepts related to Seasoned offerings describing Bought deals, Accelerated Book
Building and Right issue.

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