Investment Bank Dương Tấn Khoa

Equity Underwriting
and IPOs - Part 2

ThS. Dương Tấn Khoa

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❖The Key Steps of the IPO Process

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❖Preparation
❖Immediately after the decision of going public is
taken, the preparation of the prospectus and the
related “due diligence” begins.
❖The prospectus is basically a document
containing all the information regarding the
issuer and the issue.
❖The prospectus provides full disclosure of the
firm’s business and it is a key marketing and
protection tool for retail investors.

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❖Prospectus
❖Is a formal document that is required by and filed
with the SEC (Securities and Exchange
Commission)
❖A prospectus provides details about an
investment offering to the public. A prospectus is
filed for offerings of stocks, bonds, and other
securities.
❖The document can help investors make more
informed investment decisions because it
contains relevant information about the
investment security.

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❖Data disclose in prospectus includes:

❖ Information about the company’s business, officers,
directors, and principal shareholders and their
compensation.
❖The size of the offering, the price range, the intended
use of the funds (the proceeds), the audited financial
statements, and the risk factors.
❖ The selling shareholders (if any), underwriting
syndicate, type of underwriting, dividend policy,
dilution, capitalization, related party transactions, and
certain legal opinions.
❖The management’s discussion that examines the
company’s financial condition and results of its
operations and the business plan.

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❖Preparation (cont.)
❖To prepare the prospectus, due diligence
will be conducted
❖Due diligence is an investigation, audit, or review
performed to confirm facts or details of a matter
under consideration.
❖Due diligence requires an examination of financial
records before entering into a proposed transaction
with another party

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❖Preparation (cont.)
❖To prepare the prospectus two kinds of due
diligence are conducted: (1) business due
diligence, (2) legal due diligence.
❖Business due diligence: analyzing the feasibility
and sustainability of the business plan
❖Legal due diligence: taking care of the
prospectus structure and content.
❖The correct representation of facts and risks is
crucial for lawsuits avoidance.

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❖Approaching the market:

❖Public the pre-IPO research report.
❖The research report is prepared by the analysts of the
investment bank managing the offering.
(Before this report is released, the prospective IPO is undisclosed
to the public)
❖A quite period (or black-out period) usually follows the
pre-IPO research report.
❖In the black-out period: the investment bank does not release
any other report about the issuer, until several days after
closing.
❖In the blackout period: certain people (executives, employees,
or both) - are prohibited from buying or selling shares in their
company.
❖The primary purpose of blackout periods is to avoid booster-
shoots: analysts recommendations aimed at increasing market
demand and driving up the price
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❖Approaching the market (Cont.)

❖Once the research report is released and the IPO
is hence disclosed, the investment bank starts a
pre-marketing step, informally canvassing
institutional investors to get their “feelings” about
the issue.
❖After the pre-marketing step, a price range is set.
❖Start the roadshow
❖The roadshow combines presentations to an
audience of potential investors with meeting with
small groups and “one-on-one” with the most
important investors.
❖The book is built
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❖Going public
❖Once the book is closed, the issuer and the
investment bank set the offer price during the so-
called “price meeting.”
❖It is a crucial moment:
❖The issuer wants to maximize the proceeds
❖The investors want to make a good deal
❖The investment bank is in between!

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❖Seasoned Equity Offerings (SEOs)

❖A seasoned issue is an issue of additional
securities from an established company
whose securities already trade in the
secondary market.
❖SEO is also known as a seasoned equity
offering or follow-on public offering (FPO)
❖SEOs are surprisingly rare both in Europe
and US.

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❖Seasoned Equity Offerings (SEOs)

❖SEOs can be either:
❖Primary: new shares, thus raising fresh capital
❖Or secondary: old shares, thus reducing the existing
shareholders’ position
❖SEOs logically follow a period of strong stock
performance by the issuer as well as the market
as a whole.
❖SEOs convey negative message to investors:
WHY?

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In the US the average dollar value of the price

drop is equal to about 30% of the dollar value
of the issue itself.
For example:
 Imagine a firm with a market capitalization of

$1 billion announces a $100 million SEO.

 Assume its share price declines by the

average 3%.
 This would cut $30 million from the firm’s

market capitalization (30% of new offering)

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❖Rights offerings
❖A rights offering (rights issue) is a group of rights
offered to existing shareholders to purchase
additional stock shares in proportion to their
existing holdings.
❖In many jurisdictions a capital increase requires
the company to issue the new capital in the form
of rights to protect existing shareholders from the
dilution of their ownership stake
❖The rights are issued to the existing
shareholders at a certain ratio and at discount
relative to the current market price (call
subscription price)
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❖Rights offerings (cont.)

❖Rights are often transferable, allowing the holder
to sell them in the open market.
❖Existing shareholders are not sensitive to the
discount of the rights because of the theoretical
ex-right price (TERP).
❖The TERP is the price at which the shares
should trade at announcement of the terms of
right issue, after detachment of the rights (ex-
rights date).
❖The gross discount is the percentage difference
between the current market price and the
subscription price.
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❖TERP - Theoretical ex-right price

TERP 
 n  P   N  S 
n  N 

• n: number of shares outstanding

• N: number of new shares issued
• P: current stock price
• S: subscription price

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❖TERP example:
Stock price 2
Number of shares outstanding 1.000
Market capitalization 2.000
The firm conduct Right issue
Exchange ratio 1
(1 existing share can buy 1 new share)
Subscription price 1,5

❖What is the total number of new share issue,

the gross proceeds, the TERP, the gross
discount, the right price and the firm’s market
capitalization after the issue?
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Subscription price 1,5

New shares issued 1.000
Gross proceeds 1.500
TERP 1,75
The percentage difference
between the current market
Gross discount 25% price and the subscription price.
The percentage difference
between the TERP and the
Discount to TERP 14,29% subscription price
The difference between TERP
Right price 0,25 and subscription price
Post-right Issue
Number of shares
outstanding 2000
Market capitalization 3.500
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❖TERP example 2:
Stock price 5
Number of shares outstanding 2.200
Market capitalization 11.000
The firm conduct Right issue
Exchange ratio 75%
(100 existing share can buy 75 new share)
Subscription price 2,4
❖What is the total number of new share issue,
the gross proceeds, the TERP, the gross
discount, the right price and the firm’s market
capitalization after the issue?
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❖Stabilization
• As defined by the Security and Exchange

Commission (SEC): stabilization is “the

buying of a security for the limited purpose of
preventing or retarding a decline in its open
market price in order to facilitate its
distribution to the public”.

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❖Overallotment and the Green Shoe Option

• To assist in the stabilization effort, the

investment bank may “overallot” shares to

investors.
• The IB overallots shares obtained via a

stock lending, thus creating a short position

• The issuer usually grants the investment

bank an option to purchase shares from the

issuer itself or the selling shareholders in the
following 30 days: this is the overallotment
option, commonly called “Green Shoe”,
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❖Two scenarios after the IPO

1. The price drops: the investment bank buys

shares in the market, hoping to slow or

reverse the fall. At the end of the
stabilization period the investment bank
delivers the shares borrowed (the Green
Shoe is not exercised).
2. The price rises: the investment bank
exercises the Green Shoe: it covers its
short position without costs.

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Stabilization
Example

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❖Information related to an IPO as follow

• Number of shares underwritten by IB:

1.000.000
• Green Shoe: 100.000 (these shares are

borrowed to the investment bank)

• IPO price: 10

• Fee: 5% (of the total proceeds)

• Question: Calculate the Investment bank’s

trading profit and underwrite fee if:

a. The share price in the first trading price is 9
b. The share price in the first trading price is 11
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❖Step 1:
• The investment bank borrow 100.000 share

and sells total 1.100.000 shares at 10 per

share.
• The total proceeds are then = 1.100.000 x

10 = 11.000.000

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❖Scenario 1: Price drops to 9

• The IB buys 100.000 shares in the market (thus
contrasting the price decline)
• IB gives these 100.000 shares back to the issuer.
• The IB makes a trading profit = (10–9)x100.000 =
100.000
• The shares left floating in the market are
1.000.000.
• The total proceeds for the issuer = 10 x 1.000.000
= 10.000.000.
• The fee paid by the issuer = 5% x 10.000.000 =
500.000
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❖Scenario 2: Price increase to 11

• The IPO is a success.
• The IB exercises the call option, meaning it does
not need to give the shares back to the issuer.
• The bank has to pay to the issuer the 100.000
shares at 10 per share (the strike price).
• The shares left floating in the market are
1.100.000.
• The total proceeds for the issuer = 10 x 1.100.000
= 11.000.000.
• The fee paid by the issuer = 5% x 11.000.000 =
550.000
• Trading profit = 0
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Thank You!!!

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