Chapter 15: Investment Banking

Chapter 15

Investment BankingPublic and Private Placement

Copyright 2006. Based on Foundations of Financial Manage-ment by Stanley B. Block and Geoffrey A. Hirt, 11th ed. (2005), on slides prepared by and copyright by McGraw-Hill/Irwin, and on work by John Kevin Doyle.

2

Chapter 15 - Outline

What is Investment Banking? Functions of the Investment Banker. Underwriting Spread. Public vs. Private Companies. Advantages and Disadvantages of a Public

Company. Initial Public Offering and Leveraged

Buyout.

3

What is Investment Banking?

Investment Banking deals with primary offerings of new securities.

The Investment Banker serves as the intermediary or link between the corporation and the investor.

Brings the two parties together by channeling money from one to the other.

4

Underwriter:Buying the security and reselling it to the

public.The risk-taking function.

Market Maker: Ensuring an available market by buying and

selling the security.

Investment Banking Functions

5

Advisor:Providing advice on the type, size, and timing

of security issues.May also advise on M&A, LBO, corporate

restructuring.

Agent (a.k.a. Agency Functions):Identifying and contacting potential buyers.Negotiating the best possible deal for the

corporation.

Investment Banking Functions

6

FIGURE 15-1Distributionprocess ininvestmentbanking

7

Underwriting Spread

Spread represents the compensation for those participating in the distribution.

Spread = Public Price - Issue Price It is shared by all the participants. Spread on common stocks is greater than

the spread on bonds.

8

FIGURE 15-2Allocation of underwriting spread

9

Security Pricing

Dilution of earnings:New shares dilute the value of old shares.But, with new capital, earnings should

increase.

Market stabilization:Responsibility of investment banker.Sometimes requires repurchase of shares.

10

Security Pricing

Aftermarket:What happens to share price after offer.

Shelf registration:Mostly used for debt issues.Allows SEC approval of comprehensive (two

year) financing plan, rather than issue by issue approval.

11

Public vs. Private Companies

Public company:When shares of a company are offered to the

public.Anyone can buy shares of the stock.

Private company:Privately owned or held by an individual or

family.Not available to the general public.

12

Advantages and Disadvantages of a Public Company

Advantages of being public:Greater availability of funds (easier to grow

and raise money).Prestige.

Disadvantages of being public:Company information must be made available

to the public (opening the company up to public scrutiny and criticism).

High costs of going public (expensive).

13

FIGURE 15-4Internet Capital Group common stock price (as of May 6, 2003)

14

Initial Public Offering and Leveraged Buyout Initial Public Offering (IPO):

When a company sells its stock to the public for the first time.

The company becomes publicly traded.

Leveraged Buyout (LBO): Money is borrowed to repurchase all the

shares of the company resulting in a great deal of debt.

When a company “goes private”.