VIII Sourcing Equity Globally

Read Chapter 12. pp. 411-426 1. Designing a strategy to source equity globally 2. Foreign equity listing and issuance 3. Effect of cross-listing and equity issuance on share price 4. Barriers to cross-listing and selling equity abroad 5. Alternative instruments to source equity in global markets

Overview
Financing in global capital markets lower a firms cost of capital by improving the liquidity of its shares and by overcoming market segmentation. To access global capital markets, a firm must design a strategy to attract international investors, which requires identifying and choosing alternative paths to access global markets improving the quality and level of its disclosure making its accounting and reporting standards more transparent to potential foreign investors. We focus on firms in emerging markets and smaller industrial country markets, i.e., less liquid or segmented markets.
1-2

1. Designing a Strategy to Source Equity Globally Designing a capital sourcing strategy requires that management agree upon a long-run financial objective and then choose among the various alternative paths to get there. An investment bank often acts as an official advisor to the firm. Investment bankers are in touch with potential foreign investors and know what they currently require, and can also help navigate the numerous institutional and regulatory barriers in place.

1-3

1. Strategy: alternative path Most firms raise their initial capital in their own domestic market.

However, most firms that have only raised capital in their domestic market are not well known enough to attract foreign investors. Firms should start with an international bond offering in less liquid markets and move on to more liquid markets, and/or cross-listing equity shares on more highly liquid foreign markets.

1-4

Exhibit 12.1 Alternative Paths

Domestic Financial Market Operations International Bond Issue Less Liquid Markets International Bond Issue Target Market or Eurobond Market Equity Listings Less Liquid Markets

Equity Issue Less Liquid Markets

Equity Listing and Issue Target Market

Euroequity Issue Global Markets

Source: Oxelheim, Stonehill, Randy, Vikkula, Dullum, and Modn, Corporate Strategies to Internationalise the Cost of Capital,Copenhagen: Copenhagen Business School Press, 1998, p. 119.

1-5

1. Strategy: depositary receipts

Depositary receipts (depositary shares) are negotiable certificates issued by a bank to represent the underlying shares of stock, which are held in trust at a foreign custodian bank. Global depositary receipts (GDRs) are certificates traded outside the US.

American depositary receipts (ADRs) are certificates traded in the United States and denominated in US dollars.
ADRs are sold, registered, and transferred in the US in the same manner as any share of stock with each ADR representing some multiple of the underlying foreign share (allowing for ADR pricing to resemble conventional US share pricing between $20 and $50 per share).
1-6

Exhibit 12.2 Mechanics of American Depositary Receipts

Shares
American Depositary Receipts issued by a bank representing underlying shares held by a custodial bank

Receipts (ADRs)

Publicly traded firm outside the U.S.

Receipts for shares listed on U.S. exchange

Traded by U.S. investors

Shares

Shares traded on local stock exchange

Arbitrage Activity

1-7

1. Strategy Investors can exchange ADRs for the underlying foreign shares, so arbitrage keeps foreign and US prices of any given share the same after adjusting for transfer costs. ADRs also convey certain technical advantages to US shareholders (tax, currency, and trading, etc). While ADRs are quoted only in US dollars and traded only in the US, Global Registered Shares (GRSs) can be traded on equity exchanges around the globe in a variety of currencies.

1-8

1. Strategy Global Registered Shares are nearly identical to the structure used for Canada-US cross-listed stocks. All cross-listed Canadian stocks trade as ordinary shares, not as ADRs. Investors can trade GRSs in several exchanges, which are electronically linked. The NYSE dealing fee for ADRs cost 3-5 cents per share, and for GRS a flat cost of $5. This flat trading cost of GRS would appeal to the large institutional investors.

1-9

2. Foreign Equity Listing and Issuance

Cross-listing attempts to accomplish one or more of many objectives: Improve the liquidity of its existing shares and support a liquid secondary market for new equity issues in foreign markets Increase its share price by overcoming mis-pricing in a segmented and illiquid home capital market Increase the firms visibility Establish a secondary market for shares used to acquire other firms Create a secondary market for shares that can be used to compensate local management and employees in foreign subsidiaries
1-10

Exhibit 12.5 Size and trading volume of exchanges NYSE NASDAQ LSE Euronext Tokyo Deutsche Spain Italy # domestic # foreign volume (U$b) 1894 472 10,311 3268 381 7,254 1892 1114 2119 715 986 288 382 na 34 219 29 7 4,001 1,988 1,564 1,212 653 634

Swiss Taiwan Korea

258 638 679

140 3 0

600 634 597

1-11

2. Listing and Issuance: NYSE vs LSE NYSE is more liquid, more superior in fairness, and in crisis management than LSE.

LSE spreads are comparable to NASDAQ spread.

LSE offers advantages of being less onerous in disclosure requirements and lower listing cost, resulting in a large of foreign firms listing their shares on LSE. NYSE operates as auction market, while LSE as dealer market. Efficacy of exchange structure is an on-going issue.
1-12

3. Effect of cross-listing and equity issuance on share price

Cross-listing may have a favorable impact on share price if the new market values the firm or its industry more than the home market does (i.e., segmented markets) In segmented markets, firms can benefit from crosslisting by increasing investor recognition and participation in the primary and secondary markets. It is well known that the combined impact of a new equity issue undertaken simultaneously with a crosslisting has a more favorable impact on stock price than cross-listing alone. Even US firms can benefit by issuing equity abroad, as the foreign listing would increase investor recognition and participation in the primary and secondary markets.
1-13

4. Barriers to cross-listing and selling equity abroad

There are certainly barriers to cross-listing and/or selling equity abroad. The most serious of these includes the future commitment to providing full and transparent disclosure of operating results and balance sheets as well as a continuous program of investor relations.

One view is that the worldwide trend toward requiring fuller, more transparent, and more standardized financial disclosure may have the desirable effect of lowering the cost of equity capital.
The other view is that the US level of required disclosure is onerous and costly burden to the firms.
1-14

5. Alternative Instruments to Source Equity in Global Markets Alternative instruments to source equity in global markets include the following:
Sale of a directed public share issue to investors in a target market
Sale of a Euroequity public issue to investors in more than one market (foreign and domestic markets) Private placements under SEC Rule 144A

Sale of shares to private equity funds

Sale of shares to a foreign firm as part of a strategic alliance
1-15

5. Alternative Instruments
A directed public share issue is defined as one that is targeted at investors in a single country and underwritten in whole or in part by investment institutions from that country. A directed share issue often are motivated by a need to fund acquisitions or major capital investments in a target foreign market. The gradual integration of the worlds capital markets and increased international portfolio investment has spawned the emergence of a very viable Euroequity market. The Euro market is a generic term for international securities issues originating and being sold anywhere in the world.
1-16

5. Alternative Instruments
A firm can now issue equity underwritten and distributed in multiple foreign equity markets, sometimes simultaneously with distribution in the domestic market. The largest issues in Euroequity market have been in conjunction with a wave of privatizations of government-owned assets. Examples are British Telecom in 1984, British Steel in 1988, Deutsche Telecom (U$13.3b in 1996), Telefonos de Mexico (U$2b in 1991). It appears that many privatized firms has improved their performance following their privatizations.
1-17

5. Instruments
One type of directed issue with a long history as a source of both equity and debt is the private placement market. A private placement is the sale of a security to a small set of qualified institutional buyers (QIB) under SEC Rule 144A. The rule also allows the QIBs to trade the securities on a screen-based automated trading system called PORTAL. There are about 4,000 QIBs, maily investment bankers, investment, insurance companies, pension funds and charitable institutions.

Since the securities are not registered for sale to the public, investors have typically followed a buy and hold policy.
Private placement markets now exist in most countries.
1-18

5. Instruments
Private equity funds are usually limited partnerships of institutional and wealthy individual investors that raise their capital in the most liquid capital markets. These investors then invest the private equity fund in mature, family-owned firms located in emerging markets.

The investment objective is to help these firms to restructure and modernize in order to face increasing competition and the growth of new technologies. Private equity funds differ from traditional venture capital funds as private equity funds operate in many countries, fund companies in many industry sectors and have often have a longer time horizon for exiting.
1-19

5. Instruments Strategic alliances are normally formed by firms that expect to gain synergies from one or more of the following joint efforts: Sharing the cost of developing technology Gaining economies of scale or scope

Financial assistance (lowering of cost of capital through attractively priced debt or equity financing)

1-20

Mini-Case: Deutsche Banks Global Registered Shares

Do you believe the differences between ADRs and GRSs are real or cosmetic? Why?

Why do you think Deutsche Bank would proceed with a GRS listing when so many others have not? What do you think Deutsche Bank concluded from DaimlerChryslers experience with GRSs?

1-21