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(1)

Chapter 12

Sourcing

Sourcing

Equity

(2)

Sourcing Equity Globally: Learning

Objectives

• Design a strategy to source equity globally

• Analyze the motivations and goals of a firm issuing new equity shares on foreign equity markets

• Analyze the motivations and goals of a firm issuing new equity shares on foreign equity markets

new equity shares on foreign equity markets

• Recognize the many barriers to penetrate effectively foreign equity markets through cross-listing and selling equity abroad

• Identify the various financial instruments which can be used to source equity in the global equity markets

(3)

Designing a Strategy to

Source Equity Globally

• This requires management to agree upon a long-run financial objective and then choose among various alternative paths to get there

• Normally the choice of paths and implementation is aided by an early appointment of an investment bank as official advisor to the firm

as official advisor to the firm

• Investment bankers are in touch with the potential foreign investors and what they require in terms of risk/reward

• Investment bankers can also help navigate the various institutional requirements and barriers that must be

(4)

Designing a Strategy to

Source Equity Globally

• Most firms raise their initial capital in their own domestic market

• While many can be tempted to skip the intermediate steps to complete an Euroequity issue in global

markets, good financial advisors will offer a ‘reality check’ on this strategy

check’ on this strategy

• Most firms that have only raised capital in their

domestic market are not well enough known to attract foreign investors

• The following exhibit walks through a more probable chain of events in accessing global capital markets with the end goal being equity capital

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Domestic Financial Market Operations

International Bond Issue --Less Liquid Markets

International Bond Issue --Target Market or Eurobond Market

Alternative Paths

Equity Listing -- Target Market Equity Issue -- Less Liquid Markets

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Sourcing Equity Globally

• Depositary Receipts

Depositary receipts 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) – refers to certificates traded outside the US

certificates traded outside the US

• American Depositary Receipts (ADRs) – are certificates traded in the US 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

(7)

Sourcing Equity Globally

• Depositary Receipts

– This multiple allows the ADRs to possess a

price per share conventional for the US market

ADRs are either sponsored or unsponsored

Sponsored ADRs are created at the request of

a foreign firm wanting its shares traded in the US; the firm applies to the SEC and a US bank for registration and issuance

(8)

Shares held on deposit at custodial bank

Shares Receipts

American Depositary Receipts

Publicly traded firm outside the U.S.

Shares traded on local stock exchange

Shares

Receipts for shares listed on U.S. exchange

Arbitrage Activity

Traded by U.S. investors

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Foreign Equity Listing & Issuance

By cross-listing and selling its shares on a foreign stock exchange a firm typically tries to accomplish one or more of the following objectives:

– Improve the liquidity of its existing shares and support a

liquid secondary market

– Increase its share price by overcoming mispricing in a

– Increase its share price by overcoming mispricing in a

segmented and illiquid home market

– Increase the firm’s visibility and political acceptance to its

customers, suppliers, creditors & host governments

– Establish a secondary market for shares used for

acquisitions

– Create a secondary market for shares that can be used

to compensate local management and employees in foreign subsidiaries

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Foreign Equity Listing & Issuance

• Cross-listing is a way to encourage investors to continue to hold and trade shares that may or may not be listed on an investors home market or in a preferred currency

• Cross-listing is usually done through ADRs (in

• Cross-listing is usually done through ADRs (in the United States, where they are traded and quoted in U.S. dollars)

• GRSs, on the other hand, are able to be traded on equity exchanges around the globe in a

variety of currencies and are traded electronically

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German Equity System

Electronic Linkages

German investors can trade in equities listed on any of the three exchanges, but quoted in local currency (€)

Swiss investors can trade in equities

Global Registered Shares (GRSs)

Swiss Equity System New York Stock Exchange Electronic Linkages

Swiss investors can trade in equities listed on any of the three exchanges, but quoted in local currency (Sfr)

U.S. & Canadian investors can trade in equities listed on any of the three exchanges, but quoted in local currency,

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Effect of Cross-Listing

on Share Price

• The impact on price of cross-listing on a

foreign stock market depends on the degree to which the markets are segmented

• As was the situation experienced by Novo, a firm can benefit if a foreign market values a firm can benefit if a foreign market values a

company more highly than a home market (in a highly-segmented situation)

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Other Motives for Cross-Listing

• Increasing visibility and political acceptance

– MNEs list in markets where they have substantial physical operations

– Political objectives might include the need to meet local ownership requirements for an meet local ownership requirements for an MNE’s foreign joint venture

• Increasing potential for share swaps with acquisitions

(15)

Barriers to Cross-Listing

and Selling Equity Abroad

• Commitment to disclosure and investor relations

– A decision to cross-list must be balanced

against the implied increased commitment to full disclosure and a continuing investor relations

disclosure and a continuing investor relations program

• Disclosure is a double-edged sword

• Increased firm disclosure should have the effect of lowering the cost of equity capital

• On the other hand, this increased disclosure is a costly burden to corporations

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Alternative Instruments

to Source Equity

• 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 Euro equity public issue to investors in

Sale of a Euro equity public issue to investors in more than one market, including both 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 a part of a

(17)

Alternative Instruments

to Source Equity

• Directed Public Share Issues

– Defined as one which is targeted at investors in a single country and underwritten in whole or in part by investment institutions from that country

• Issue may or may not be denominated in the • Issue may or may not be denominated in the

currency of the target market

• The shares might or might not be cross-listed on a stock exchange in the target market

• A foreign share issues, plus cross-listing can provide it with improved liquidity

(18)

Alternative Instruments

to Source Equity

• Euroequity Public Issue

– Gradual integration of worlds’ capital markets has spawned the emergence of a Euroequity market

– A firm can now issue equity underwirtten and

– A firm can now issue equity underwirtten and distributed in multiple foreign equity markets; sometimes simultaneously with distribution in the domestic market

– As we have reviewed, the term “Euro” does not imply that the issuers or investors are located in Europe, nor does it mean the shares are sold in the currency “euro”

(19)

Alternative Instruments

to Source Equity

• Private Placement Under SEC Rule 144A

A private placement is the sale of a security to a small set of qualified institutional buyers

– Investors are traditionally insurance companies and investment companies

and investment companies

– Because shares are not registered for sale,

investors typically follow “buy and hold” strategy

– Rule 144A allows qualified institutional buyers (QIB) to trade privately placed securities without previous holding period restrictions and without requiring SEC registration

(20)

Alternative Instruments

to Source Equity

• Private Equity Funds

– Limited partnerships of institutional and wealthy individual investors that raise their capital in the most liquid capital markets

– Then invest these funds in mature,

family-– Then invest these funds in mature, family-owned firms located in emerging markets

• Strategic Alliances

– Normally followed by firms that expect to gain synergies from one or more joint efforts

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Summary of Learning Objectives

• Designing a capital sourcing strategy requires management to agree upon a long run financial objective

• The firm must then choose among the various alternative paths to get there, including where alternative paths to get there, including where to cross-list its shares and where to issue new equity and in what form

(22)

Summary of Learning Objectives

A firm cross-lists its shares on foreign stock exchanges for one or more of the following reasons

– Improving liquidity of its existing shares through

depositary receipts

– Increase its share price by overcoming mispricing by a

– Increase its share price by overcoming mispricing by a

segmented, illiquid home market

– Support a new equity issue sold in a foreign market

– Establish a secondary market for shares used in

acquisitions

– Increase the firm’s visibility & political acceptance to its

customers, suppliers, creditors and host governments

– Create a secondary market for shares that will be used

(23)

Summary of Learning Objectives

• If it is to support a new equity issue or to

establish a market for share swaps, the target market should also be the listing market

• If it is to increase the firm’s commercial and political visibility or to compensate local

political visibility or to compensate local

management and employees, it should be in markets in which the firm has significant

operations

• The major liquid stock markets are the NYSE, NASDAQ, LSE, Euronext, Tokyo, and

(24)

Summary of Learning Objectives

• By cross-listing and selling equity abroad, a firm faces two barriers

– Increased commitment to full disclosure

– A continuing investor relations program

• Non-U.S. firms must think twice before cross-listing in the United States. Not only are the disclosure requirements onerous, but

continuous timely quarterly information is

required by U.S. regulators and investors. This is very costly.

(25)

Summary of Learning Objectives

• A firm can lower its cost of capital and increase its liquidity by selling its shares to foreign investors in a variety of forms

– Sale of a directed share issue to investors in one

particular foreign equity market

– Sale of a Euroequity share issue to foreign investors

– Sale of a Euroequity share issue to foreign investors

simultaneously in more than one market, including both foreign and domestic markets

– Private placement under SEC rule 144A

– Sale of shares to private equity funds

– Sales of shares to a foreign firm as part of a strategic

(26)

Mini-Case: Deutsche Bank’s Global

Registered Shares

• Since 1927 foreign companies have listed their shares on the New York Stock Exchange by

issuing ADRs

• Foreign companies have found the ADR

system a very corporate-friendly system by system a very corporate-friendly system by which foreign corporations could reach

investors in the New York equity capital markets

• In October 2001, Deutsche Bank of Germany decided to list via GRSs instead of ADRs

(27)

Mini-Case: Deutsche Bank’s 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?

others have not?

• What do you think Deutsche Bank concluded from DaimlerChrysler’s experience with GRSs?

(28)

Exhibit 12.1 Alternative Paths to Globalize

(29)

Exhibit 12.2 Mechanics of American

Depositary Receipts (ADRs)

(30)

Exhibit 12.3 Characteristics of

Depositary Receipt Programs Traded in

the United States

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(32)

Exhibit 12.5 Selected Stock Exchange

Size Characteristics and Market Liquidity,

End 2002

(33)

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