Debt Overhang Problem
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Debt Overhang Problem If a company has risky debt outstanding, the cash infusion associated with an equity offer increases the collateral backing the debt, making it less risky What effect does this have on the existing shareholders?
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Debt Overhang Problem. If a company has risky debt outstanding, the cash infusion associated with an equity offer increases the collateral backing the debt, making it less risky What effect does this have on the existing shareholders?. Example with a $200 million equity issue. - PowerPoint PPT Presentation
Transcript of Debt Overhang Problem
Debt Overhang Problem
If a company has risky debt outstanding, the cash infusion associated with an equity offer increases the collateral backing the debt, making it less risky
What effect does this have on the existing shareholders?
Example with a $200 million equity issue
Pre-issue enterprise value of $1 billion Face value of debt of $900 million Market value of debt of $600 million 100 million shares outstanding at $4 per share
After equity issue, risky debt increases to market value of $750 million
What is the post-issue enterprise value?
How many shares have to be issued to raise $100 m?
$1,200 m enterprise value - $750 million MV debt = $450 m post-issue equity value
$450 million = price/share×(100 m old shares + new shares)
$200 million = price/share×new shares
Solve for price/share
New shares = $200 m ÷ price/share $450 MV of equity = (100 + 200/price) × price/share
450 = 200 + 100 × price/share
Price/share = $2.50
New shares to be issued to raise $200 million is 80 million
Seasoned Equity Offerings(Follow-on Offerings)
Rights offers
A rights offer involves offering shares to existing shareholders at a fixed exercise price
These are rare in the U.S.
Equity Capital Raised by US and European Financials in 2008
UBS $15.3 billion rights offer AIG $13.4 billion SEO
($7.5 fully marketed common but only 4 days) ($5.9 billion convertible)
Washington Mutual $7.2 billion private equity by TPG Societe Generale $8.5 billion rights offer Citigroup $4.9 billion accelerated bookbuild Citigroup $12.5 billion convertible sovereign funds Citigroup $3.2 billion convertible JP Morgan Chase $11.5 billion accelerated bookbuild
Follow-on Offers
Frequently occur after a large stock-price runup
On average, the stock has gone up 70% in the year prior to the announcement, although there is wide variation around this number
New Development Accelerated seasoned equity offerings (SEOs),
including bought deals and accelerated bookbuilt offers, have become more common throughout the world during the last decade (Bortolotti, Megginson, and Smart, Summer 2008 Journal of Applied Corporate Finance)
September, 2008
Two Types of Accelerated SEOs
Bought dealsThe issuing firm (or the selling shareholder) announces the amount of stock it wishes to sell and invites investment banks to bid. The investment bank that offers the highest net price wins the right to buy the shares. The winning bank then re-sells the shares immediately.
Accelerated bookbuilt offersThe investment bank that wins the right to underwrite the offer builds an order book and sets the final offer price very rapidly, usually within 48 hours.
September, 2008
What is Special about Accelerated SEOs? The most important differences between an accelerated
SEO and a fully marketed SEO are the amount of marketing and the speed to market
Similar to an IPO, in a fully marketed SEO, the lead underwriter conducts a road show after the registration
There is NO road show conducted for bought deals and accelerated bookbuilt offers, which implies little marketing effort
Shares in accelerated SEOs are generally allocated exclusively to institutional investors
September, 2008
The Fully Marketed SEO Process (Figure 1)
September, 2008
Select book-runner and co-managers
Registration
Marketing, road show, andbook-building
Issue final prospectus, pricing, and allocation
Announcement of the filing
Trade begins
2 – 3 weeks
Prepare preliminary prospectus
The Bought Deal Process (Figure 1)
September, 2008
Investment banks submit bids after the close of trading
Bank that offers the highest net price wins
Re-sell the shares
Announcement of the filing
Trade begins
Usually overnight
Registration
The Accelerated Bookbuilt SEO Process (Figure 1)
September, 2008
Select the book-runner
Accelerated bookbuilding
Pricing and allocation
Announcement of the filing
Trade begins
Usually 1-2 days
Registration
Demand Curve without Marketing
September, 2008
1P
2P
1X 2X
NX p
Supply
Demand
Price
Quantity
Marketing Effects
Marketing flattens the demand curve
Marketing changes current shareholders’ beliefs
Marketing increases the number of investors paying attention to the stock
Demand Curve with Marketing
September, 2008
1P
2P
1X 2X
*P
Price
Supply
Demand
With Marketing
Without Marketing
Quantity
NX p
N M X p
Model Predictions The fully marketed offer method is preferred to the
accelerated offer method if: The ex ante demand curve of the issuing firm’s
stock is relatively inelastic The offer size is large
September, 2008
Asymmetric Information Theory
September, 2008
1P
2P
1X 2X
Supply
Demand Signal of Overvaluation
Quantity
Price
Announcement Returns Announcement returns incorporate
anticipated price pressure effects Otherwise an arbitrage opportunity exists
What We Observe on the Announcement Day
1P
2P
1X 2X
P
Supply
Information and Price Pressure
Demand
Quantity
Price
Number of SEOs by Year and Offering Method
Sample SEOs Bought Deals Accelerated Bookbuilt SEOs Fully Marketed SEOs
Year Number
Total Proceeds ($
billion)
Number
Total Proceeds ($
billion)
Number
Total Proceeds ($
billion)
Number
Total Proceeds ($
billion)
1996 400 43.38 1 0.06 0 0.00 399 43.321997 359 32.30 2 0.45 8 1.40 349 30.451998 250 24.52 8 1.40 2 0.03 240 23.051999 298 32.03 19 2.51 2 0.32 277 29.202000 311 49.16 27 2.94 2 0.07 282 46.152001 232 32.18 35 6.34 17 1.47 180 24.382002 223 37.86 25 5.48 41 10.36 157 22.022003 254 28.25 36 6.09 42 5.15 176 16.882004 283 28.06 35 4.51 51 6.58 197 16.902005 219 21.95 32 3.91 29 3.17 158 14.872006 236 19.37 43 3.73 36 6.58 157 11.882007 211 20.91 27 1.99 46 3.17 138 14.52
Offer Characteristics (Means)
All SEOs Bought Deals
Accelerated Bookbuilt SEOs
Fully Marketed SEOs
Normalized Market Capitalization ($M) 1,183 2,795 2,718 855
Normalized Proceeds ($M) 176 220 208 168
Relative Offer Size (%) 22.53 9.26 11.37 25.09
Number of Days from Filing to Offer 26 0 1 31
Average Gross Spreads Conditional on Offer Mechanism
All SEOs Bought Deals Accelerated Bookbuilt SEOs
Fully Marketed SEOs
Gross Spread (%) 4.82 2.28 4.23 5.10
Average Announcement Effect and Underpricing
All SEOs Bought Deals Accelerated Bookbuilt SEOs Fully Marketed SEOs
Announcement Effect (%) -1.72 -1.49 -2.55 -1.66
Underpricing (%) 3.11 1.09 2.10 3.43
