LOYOLA INSTITUTE OF BUSINESS ADMINISTRATION

IPO AND ITS IMPACTS

INVESTMENT BANKING ASSIGNMENT

ALPHONSE RAJ DAVID (F13004)

CAROL S DENNIS (F13017)

CRISTOPHER ANAND (F13022)

SOUMEN BISWAS (F13113)

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Contents

Introduction ............................................................................................................................................. 2

Ordinary (equity) shares ..................................................................................................................... 2

New shares issues ............................................................................................................................... 2

Initial Public Offering (IPO) ................................................................................................................... 3

The Pros of going public ..................................................................................................................... 3

The cons of going public ..................................................................................................................... 4

Costs associated with IPO ................................................................................................................... 5

Going public .................................................................................................................................... 5

Being public ........................................................................................................................................ 5

The Financial Dimension of IPO decision .......................................................................................... 6

Nature of business ........................................................................................................................... 6

Unlocking value .............................................................................................................................. 6

Quantum of capital to be raised ...................................................................................................... 6

Unlocking Value Using IPOS ................................................................................................................. 7

Facebook ............................................................................................................................................. 7

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Introduction

In the world of finance there are many different options available to businesses of all sizes and types. The

overall goal of business financing is to raise the capital to meet your businesss current needs. Those needs

can range from equipment purchases to renovations, all of which will help your business to grow further in

its industry. Next is to get this capital at the least cost for the business to ensure that the fund raiser will be

able to meet the repayment obligation.\

It is worthwhile for organizations to consider all possible forms of financing before making their final

decisions. Financial managers must be aware of their sources of long term funds so that they can finance

projects in a manner that maximizes the wealth of the corporation.

A company might raise new funds from the following sources:

The capital markets:

- new share issues, for example, by companies acquiring a stock market listing for the first time

- rights issues

Loan stock

Retained earnings.

Bank borrowing

Government sources

Business expansion scheme funds

Venture capital

Franchising.

Ordinary (equity) shares

Ordinary shares are issued to the owners of a company. The market value of a quoted company's shares

bears no relationship to their nominal value, except that when ordinary shares are issued for cash, the issue

price must be equal to or be more than the nominal value of the shares.

New shares issues

A company seeking to obtain additional equity funds may be:

a) An unquoted company wishing to obtain a Stock Exchange quotation

b) An unquoted company wishing to issue new shares, but without obtaining a Stock Exchange quotation

c) A company which is already listed on the Stock Exchange wishing to issue additional new shares.

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The methods by which a company can raise capital from the equity market are:

a) An offer for sale

b) A prospectus issue

c) A private placement

In prospectus issue, the firm gets listed to a recognized stock exchange and the shares are issued to the

prospective investors for the first time after which the shares can be traded on the exchange. This process of

raising capital for long term financing of projects is known as initial public offering (IPO).

Initial Public Offering (IPO)

For many growing companies, "going public" is more than just selling stock. It's a signal to the world that

the business has made it. That's why undertaking an initial public offering (commonly known as an IPO) --

the first sale of stock to the public by a private company -- has long been the ultimate goal for many an

entrepreneurial business. An IPO can not only provide a company with access to capital to fuel growth and

liquidity for founders and investors, but it provides the public market's unofficial stamp of approval.

An IPO is one of the most significant events in the life of a business. The capital raised through a successful

public offering boosts a business' ability to expand into new market s or grow through acquisitions. It can

help a company attract new talent with stock options and other equity awards and reward initial investors

with liquidity. The fact that you're a public company gets you in the door with vendors and suppliers and

prospective business partners. Being a publicly traded company has additional cache and is something that

can be helpful to a company in its commercial relationships.

Such benefits, however, don't come without costs. One important intangible cost to consider is the loss of

control over the business when a formerly private company goes public.

The Pros of going public

1. Greater access to funds since the company can return to public markets for additional capital and access

alternative financing on favourable terms from private investors as well.

2. Provides a more liquid and diversified share capital base and a liquid currency for acquisitions.

3. Enhances prestige, brand image, public profile and credibility.

4. Facilitates future acquisitions of other business which may be paid for at least partially in a public

companys shares.

5. Achieves higher valuations than private enterprises since greater disclosure of information reduces

uncertainty around performance and increases value.

6. Provides a potential exit strategy and liquidity for investors, owners and shareholders.

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7. Attracts, retains and rewards valued employees through share option plans.

8. Enhances benchmarking operations against other public companies from same industry

9. Retains future upside potential in business

10. Opportunity for reducing debt or refinancing.

(Source: EYs guide to going public)

The cons of going public

1. Highly distracting and time consuming due to need for periodic reporting and investor relations

2. High costs due to initial and ongoing expenses, including payments to external advisors for regulatory

compliance and maintaining a listing

3. Limits on managements freedom to act including need for approval of board or shareholders on many

major matters.

4. Potential loss of control and privacy since there is a need to reveal highly sensitive information in public

reports

5. Shareholders expectations can create pressure on management to perform

6. Difficulty in recruiting good non-executive directors for board

7. Limited window of opportunity of access to IPO markets so compromise on price may be necessary

8. Corporate governance requirements include business process improvements and non-executive directors

oversight.

(Source: EYs guide to going public)

So after considering the pros and cons of going public for fund raising, the companys management should

focus on the following factors before taking the final decision:

1. Business model and management capability

2. Growth potential and market size

3. Financial track record

4. Valuation and comparative value

5. Shareholders objectives

6. Current stage of development in company life cycle

7. Prospects and position within industry

8. Investor base and analyst coverage

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Costs associated with IPO

Going public

1. Underwriter discount, which based on public registration statements, result in fees equal to 5%-7% of

gross proceeds

2. Legal, accounting and printing fees associated with drafting the registration statement and comfort letter

3. Road show expenses

4. In addition to underwriter fees, on average companies incur $3.7 million of costs directly attributable to

their IPO

Being public

1. Costs to implement new financial reporting systems and processes

2. Tax and legal entity restructuring costs in anticipation of the IPO

3. Additional audit, interim/quarterly review costs, advisory accounting and other costs to make the financial

statements compliant with regulatory authorities.

4. Costs to identify and recruit a new board of directors

5. Professional fees for legal and accounting advice

(Source: PWC: cost of IPO)

From the above, it is evident that IPO can be a mixed bag for a company. Therefore, strategically speaking

and given a choice, a company should go for an IPO only when it is mature enough for it. This would depend

on the following:

1. Does the company need the IPO as a liquidity event for its existing investors? In other words, are there no

private exit options available so that the IPO can he pushed further into the future?

2. Has the company matured enough to unlock value? Every company eventually needs to unlock value by

sharing its wealth with a wider section of investors and growing bigger with their support thereafter. This is

probably the only way corporations grow to become citadels of wealth creation for a fairly long time.

3. Is the companys business model retail-oriented with strong brand presence so as to identify with the retail

investor?

4. Is the companys visibility in the market sufficient enough for investors to perceive its business model to

the full extent and unlock value for its shareholders through the IPO?

5. Is the company confident of strong financial growth in the future to sustain the pressure of constant market

validation after the IPO?

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The Financial Dimension of IPO decision

Nature of business

In some industries, going public may not be the decision of choice. In capital intensive industries such as

cement, steel or shipping, in large industries such as heavy engineering, automobiles, infrastructure and

refineries, in volume based industries such as pharmaceutical formulations, energy trading and transportation

etc. the business model is so large that going public could become inevitable to maintain balance in the

capital structure. Companies engaged in these kind of businesses need to go public sooner or later to finance

their business plans. They would also require multiple rounds of public offers after the IPO to keep financing

their growth and consolidation.

Therefore, in such cases, IPO and public offers are more of financing decisions than strategic.

The same is true of certain start-up businesses that need to look at an IPO more as a source of finance than

as a strategic move. Though regulations have been brought in to prevent flimsy start-ups from making IPOs

and going belly up thereafter, it is possible for fundamentally strong and well- conceived business plans to

go public at the initial stage itself. Reliance Petroleum is a case in point that went public even before the

project was implemented.

Unlocking value

The second financial aspect relating to the IPO decision is to evaluate if unlocking value through an IPO is

the need of the hour or whether other options are available. As explained above, as long as a company has

access to private equity that does not require a market exit route in the near future, the company can look to

raise funds through strategic sale of equity and not through an IPO. Strategic sale of equity happens through

the private window that realizes better value for the company than an IPO, since private investors offer

valuations significantly higher than what the company can command in the retail market. This point is well

illustrated in the case of Bharat Petroleum Corporation Ltd. While the erstwhile Disinvestment Ministry in

the Union Government maintained that a strategic sale to a private investor would realize higher value for

the privatization, the Petroleum Ministry insisted on the public issue route for the same. However, in the

case of Hindustan Petroleum Corporation Ltd. the petroleum ministry agreed to a strategic sale. The main

argument in favor of a public issue in privatization process is that it is more transparent and leads to better

sharing of wealth.

Quantum of capital to be raised

The third aspect of the financial dimension is to evaluate how much capital is proposed to be raised through

the IPO and its deployment. Generally IPOs tend to have well laid out investment plans sell better than those

that do not have convincing application for the funds. Investors need to be shown an investment avenue in

the company that can generate the expected return on their funds. Sometimes, the requirement of funds for

the company could be too large to be raised through an IPO without causing too much dilution of promoter

stakes. At such times, the company has to formulate an ideal issue structure in consultation with the merchant

banker and prune down the size of the issue if necessary. Similarly, if the fund requirement were too small

to warrant an IPO, it would not be prudent to go ahead with it.

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Unlocking Value Using IPOS

Till now we have discussed the theoretical aspects of IPOs. There are many reasons why IPOs

are important for the successful running of a company. One of the main reasons in recent times has

been unlocking of the companys values. Let me explain. In the olden days what that is in the 1970s

and the 1980s we found that most companies went public very early in their lifecycle. The best

examples are those of Apple and Microsoft wherein the companys IPO where done in the growth

phase of the company. This was done mainly due to the capital requirements of the companies given

as examples. But as discussed earlier there are lot of cons in doing so especially if you are a growing

company as not only will you have a pressure to grow but also a pressure to give returns to

shareholders. But that was then

Now in the 21st century we have a varied and myriad ways by which a company can get cash

for the growth of the company whilst still keeping it private. They are venture capitalist funding,

Angel Investing and so on and so forth. But all of them require returns and the best form of returns for

a venture capitalist is when he does an IPO. These IPOs tend to be later in the company life cycle so

that the company will be worth more. Thus there is nowadays a new reason for IPOing that is to

unlock the value of the companies. The pros and cons of this method are many and the societal

impacts like involement of the middle class in a companys growth story (Apple IPOed at a billion

dollars and is now worth over 600 billion dollars but Facebook IPOed 100 Billion dollars so even if it

touches 1000 billion in 40 years it will only be a 10x return compared to the 600x returns of Apple).

But that discussion is outside the scope of this paper and here in the following pages we will give a

few examples of IPOs used for unlocking values for companies

Facebook Inc.

From Peter Thiel to Microsoft to Digital Sky technologies all had a piece of Facebook which was being

valued at around $50 billion dollars in 2011(Source: http://dealbook.nytimes.com/2011/01/02/goldman-

invests-in-facebook-at-50-billion-valuation/)

Although Zuckerberg was not interested in taking the company public the need to keeping in best talent and

the pressure from early VCs looking for exits was too much for him.

Let me explain. Expect for the first 200 employees all other employees got restricted stock units wherein

they can only sell their stock when the company goes public. This led to employee morale coming down as

this policy has been in place for more than 5 years as of 2012 when the company IPOed. Although in the

early years this was a very good method of retaining employees this led to resentment as time went on and

employees started grumbling.

A normal VC fund lasts for 7 years. Facebook was started in 2004 and went public in 2012. This is not a

coincidence. The early VCs where all clamouring for an exit and the best way for a VC fund to exit has

always been to get a IPO so in this case Zuckerberg had to capitulate and go in for an IPO

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Another important reason for unlocking value is to acquire companies. IPOs give good cash at a heightened

valuation. This enables Facebook to buy over companies which where being a threat. Acquiring Instagram

and Whatsapp wouldnt have been possible if Facebook hadnt IPOed

Alibaba

Alibaba is Chinas and by some measures, the worlds biggest online commerce company. Its three main

sites are Taobao, Tmall and Alibaba.com have hundreds and millions of users, and host millions of merchants

and businesses. Alibaba handles more business than any other e-commerce company.

Alibaba is the most popular destination for online shopping, in the world's fastest growing e-commerce

market. Transactions on its online sites totalled $248 billion last year, more than those of eBay and

Amazon.com combined.

(http://www.wsj.com/news/articles/SB10001424052702304644104579191590951567808)

The mammoth IPO planned by e-commerce giant Alibaba Group highlights founder Jack Mas improbable

rise to Chinas entrepreneur-in-chief.

Ma, a former English teacher who flunked his college entrance exam twice, founded Alibaba in his apartment

in 1999 with 17 friends and $60,000 they had raised. Charismatic by the gray standards of Chinese CEOs,

the impish Ma has cult status in China, where hes seen as the equivalent of Steve Jobs, Jeff Bezos or Bill

Gates.

In a country where state-owned enterprises dominate business and many owe their wealth to Communist

Party ties, Ma stands out for his huge self-made success. Alibaba, which started as a site to link Chinese

manufacturers with buyers overseas, became under Ma an e-commerce behemoth that is now expanding into

banking, digital maps and online video.

The paperwork for Alibabas initial public offering says it will raise at least $1 billion from the U.S. listing,

but finance professionals believe that is a conservative notional figure to get the IPO process rolling.

Estimates for the amount that could be raised have ranged from $10 billion to $20 billion. The price at which

shares are sold might give Alibaba a market valuation of $200 billion, which is greater than Facebook.

Ma, who owns 8.9 percent of the company, is likely to become even wealthier following the IPO. Hes

already worth $8.4 billion, making him Chinas fifth-richest person, according to Forbes.

The entrepreneur may have inherited his knack for showmanship from his parents, who were performers of

pingtan, a traditional form of storytelling and balladry that was banned during the violent upheaval of the

Cultural Revolution.

As a boy, he was terrible at math but better at English and improved it by volunteering as tour guide in

Hangzhou, a picturesque city near Shanghai. He earned an English degree from Hangzhou Teachers

Institute after passing the college exam on the third try. He taught at a local college, then set up his own

translation company but moonlighted as a street peddler, hawking flowers, books, flashlights and clothes, to

balance the books.

Ma first encountered the Internet in 1995. After word got around about his English proficiency, he was asked

to help sort out a road construction project that was going sour over unpaid debts by meeting the American

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joint venture partner in California. Ma soon realized he had no intention of paying up. To stop Ma from

leaving, the American locked him in his Malibu mansion for several days and, by some accounts, flashed a

gun.

Ma persuaded the American to let him go by telling him they could work together on a project involving the

Internet, which he had heard about vaguely. Instead of heading home, he flew to Seattle, where he met some

contacts who showed him the World Wide Web. A search for beer turned up results on American, German

and Japanese varieties but no Chinese beer. Ma was intrigued and the potential for an Internet company

devoted to things Chinese dawned on him.

The seeds for Alibaba were planted with China Pages, which Ma founded in 1995 with $2,400 scraped

together from relatives. It created websites for local businesses, starting with his translation firm. He

partnered with a state-owned enterprise but the venture stumbled after a falling out.

He worked briefly at an e-commerce venture in Beijing backed by the Ministry of Foreign Trade and

Economic Cooperation but left because of the lack of dynamism. He went back to Hangzhou to set up

Alibaba, a business-to-business website that linked Chinas countless exporters with buyers around the

world. He picked the companys name because of the universal appeal of the Arabian Nights story and

associated catchphrase Open Sesame.

The company launched retail website Taobao in 2003 to compete with eBay in China. Ebay shuttered its

China site in 2006, a major victory for Ma.

Alibaba's initial public offering now ranks as the world's biggest at $25 billion, netting underwriters of the

sale a more than $300 million windfall after the e-commerce giant and some shareholders parted with

additional shares.

The fees are equivalent to 1.2 percent of the total deal, with Alibaba paying $121.8 million in commissions.

Selling shareholders are set to pay another $178.6 million, according to a filing with the U.S. Securities and

Exchange Commission on Monday.

Overwhelming demand saw the IPO initially raise $21.8 billion, and then sent Alibaba Group Holding Ltd's

stock surging 38 percent in its debut on Friday. That prompted underwriters to exercise an option to sell an

additional 48 million shares, a source with direct knowledge of the deal said.

That means the IPO has surpassed a previous global record set by Agricultural Bank of China Ltd in 2010,

when the lender raised $22.1 billion.

According to its prospectus, Alibaba had agreed to sell 26.1 million additional shares under the option, and

Yahoo Inc an additional 18.3 million, netting the two companies an extra $1.8 billion and $1.2 billion

respectively.

Alibaba's Jack Ma had agreed under the same option to sell an extra 2.7 million shares and company co-

founder Joe Tsai agreed to 902,782 additional shares.

Citigroup Inc, Credit Suisse Group AG, Deutsche Bank, Goldman Sachs Group Inc, JPMorgan Chase & Co

and Morgan Stanley acted as joint bookrunners of the IPO. Rothschild was hired as Alibaba's independent

financial advisor on the deal.

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Alibaba Group Holding Ltd's shares soared 38 percent in their first day of trading as investors jumped at the

chance for a piece of what is likely to rank as the largest IPO in history, in a massive bet on China's

burgeoning middle class.

The stock opened at $92.70 shortly before noon ET (1600 GMT) and quickly rose to a high of $99.70, before

paring gains to close at $93.89. Some 271 million shares changed hands, more than double the turnover on

Twitter Inc's first day last year, although still short of volume for the General Motors Co and Facebook Inc

IPOs.

The pricing of the IPO initially raised $21.8 billion for Alibaba.

Alibaba is nearly unknown to most Americans but is ubiquitous in China. The company, which operates

China's largest Internet shopping destination, Taobao, and retail site Tmall.com, earned $3.7 billion in the

12 months ended March 31, 2014, up about $2 billion from the prior 12-month period.

At its closing share price on Friday, Alibaba has a market value of $231 billion, exceeding the combined

market capitalizations of Amazon and eBay, the two leading US e-commerce companies.

Alibaba is valued at 39 times its estimated earnings per share for its current fiscal year, which ends in March.

That is right in line with Facebook's valuation of 39 times forward earnings but nowhere near the lofty

valuation of Amazon.com's multiple of 264, according to Thomson Reuters Starmine data.