IPO Basics

A Primer
What is Primary Market and Secondary
Market?
The primary market is where securities are created.
It's in this market that firms sell new stocks and bonds to the public for the
first time
Primary market can be called as being synonymous with an Initial Public
offering (IPO)
The secondary market is what people are talking about when they refer to
the "stock market
That is, in the secondary market, investors trade previously issued
securities without the issuing companies' involvement
The secondary market can be further broken down into two specialized
categories: auction market and dealer market.

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What is an IPO?
An Initial Public Offering is when a company offers its shares to the
public at large for the first time. Hence also referred to as going
public.
The shares are listed on a stock exchange and can be traded after an
IPO. Anyone can buy the shares and become part owner of the firm.
Private unlisted firms have restrictions on the number of shareholders
(owners) as well as on the transfer of shares.
By carrying out an IPO and listing its shares, the company opens itself
to ownership by the general public. This also brings with it greater
scrutiny and regulatory disclosures than a private company.
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Types of Shares Offered

Primary Shares Secondary Shares

Company issues new shares Existing shareholders sell part or all of their shares
Money from investors who buy these shares go to the Money from the sale of these shares goes to the existing
company. On the companys balance sheet, the equity shareholder making the sale
capital value increases
More compelling for investors as existing shareholders
arent leaving
Existing shares
Companys outstanding
New shares
shares
Shareholder A Shareholder B Shareholder C
Money from the sale of these
shares goes to the company

Shareholder A selling part of stake

Total equity shares of the company after sale Shareholder C selling entire stake

This is known as a fresh issue This is known as an offer for sale

 Examples
Frequently, IPOs involve both fresh issues and OFS (Offers for Sale)

Source:
http://www.livemint.com/Companies/ZbunhNYPimA1ddYsGd68ZK/Numero-Uno-Clothing-files-
IPO-papers-with-Sebi.html

Source:
http://www.business-standard.com/article/companies/indigo-files-
documents-for-rs-2-500-cr-ipo-115070100047_1.html

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Reasons to do an IPO
Once listed, the company finds it easier to raise more capital from the market
Listed companies face high level of scrutiny from regulators, which makes investors comfortable
Liquidity (ease of buying and selling)
Since the public at large owns & trade shares after an IPO, its easier to buy and sell shares
Difficult to find a buyer or seller in case of unlisted company. Many restrictions on sale & transfer
of shares.
Exit for promoters/investors
Some investors may want to exit their holding
Market valuation
The market now determines the value of the company through share price. This gives a more
reliable valuation.
Employee Stock Options (ESOPs)
Incentive to employees
Being listed brings a lot of visibility to the company

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Cons of doing an IPO
Public companies are required to disclose a great amount of information this may force
revelation of competitive information and strategies
Listed companies are subject to stricter scrutiny and regulation
The share value of the company is subject to market sentiments. Even a sound company may be
adversely affected by a negative sentiment in the market
Activist investors may pressurize management

Life is tough when you IPO.

- Jack Ma, Founder, Alibaba
http://blogs.wsj.com/moneybeat/2015/06/09/in-another-life-jack-ma-says-hed-
forgo-alibabas-ipo/

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What does an Investment bank look for when
a company comes to it for an IPO?
Is this the right thing to do? Should we pick another way to raise capital?
Are the markets ready for this? (you dont want to conduct an IPO in a bad
environment or when your company will not be understood for it true worth)
Plan of action
Listing venue: Pick venue which gives
higher valuation (reflected by high P/E, P/B ratios)
comfort for listing company (a Chinese company may prefer to list in Hong Kong than in New York)
investor interest (tech companies prefer to list in the US as American investors are considered better
informed about such companies)
Assemble a core team of lawyers, accountants, consultants, etc.
Typically, the issuing companies invites Requests for Proposals (RFPs) from banks.
It picks banks from the beauty parade. The picked banks form the syndicate
responsible for carrying out the IPO.
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Other key responsibilities & decisions for an I-
bank
Procedures
Coordinate prospectus drafting (prospectus is a document containing important material
information about the issuing company & the offer for prospective investors)
Obtain necessary regulatory approvals SEBI, Registrar of Companies, Stock Exchanges
How much to sell?
IPO Size
Primary-secondary mix
How to sell?
Equity story why is it a good company to invest in
Engage investors
Roadshows meetings between important prospective investors and company management
are a common marketing tool for the sales of shares
Who will buy it?
Pick the right investor to market to.

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M&A Basics
A Primer
Mergers and acquisitions Definitions
Merger with Consolidation Acquisition

Company
Company
A
X

Company Company
C X
Company
Company
B
Y

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Types of Mergers and Acquisitions
Classified by the relatedness of business activities of the parties to the combination:

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Motives/Benefits of an M&A
For greater market share & access to customers
Eg. Kotak Mahindra banks acquisition of ING Vyasya Bank
Vertical integration moving up or down the value chain (acquiring your
supplier or customer)
Eg. A steel company could acquire an iron-ore mining giant (backward integration)
For technology & intellectual property
Eg. Googles acquisition of Motorola
Financial reasons tax savings, buying something cheap and selling it dearer
Diversification
Eg. ITCs acquisition of Savlon from Johnson & Johnson
Eliminate competition
Increase bargaining power
A larger combined entity will have more negotiating power than 2 smaller entitites
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Bankers Role in an M&A
Identification of the right assets
Benchmark potential targets
Zero in on best fit
Valuation of the target
Financial modelling
Analyse similar precedent transactions, similar companies
Due diligence
Check all claims and assumptions business, financial, legal, etc.
Negotiation with the other party
Regulatory clearances anti-trust, competition commission, other regulators
How to go about the acquisition
Structure
How to fund acquisition
Debt
Equity

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Transaction Characteristics of M & A

Form of the Stock purchase

Transaction Asset purchase

Cash
Method of Payment Securities
Combination of cash and securities

Attitude of Hostile
Management Friendly

Accretive
Types of M & A
Dilutive

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15
Forms of an Acquisition Types of M & A
In a stock purchase, the acquirer Accretive transaction: An
provides cash, stock, or combination of
cash and stock in exchange for the stock acquisition that will increase the
of the target firm. acquiring company's earnings per
A stock purchase needs shareholder
approval. share (EPS).
Target shareholders are taxed on any gain.
Acquirer assumes targets liabilities. Dilutive transaction: An acquisition
In an asset purchase, the acquirer buys that will decrease the acquiring
the assets of the target firm, paying the company's earnings per share
target firm directly.
An asset purchase may not need shareholder (EPS).
approval.
Acquirer likely avoids assumption of
liabilities.

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Types of Purchase consideration
Cash offering Recent news:-
Cash is paid to the shareholders of the target Warren buffets announcement of
company for their stocks acquisition of Precision Castparts for an all
cash consideration of US$37 billion
Securities offering
Target shareholders receive shares of common Recent news:-
stock, preferred stock, or debt of the acquirer in Amalgamation of Strides arcolab and
exchange of their stocks in the target. Shasun Pharmaceuticals is an example of an
The exchange ratio determines the number of all stock deal
securities received in exchange for a share of
target stock.
Factors influencing method of payment:
Sharing of risk among the acquirer and target
shareholders.
Signaling by the acquiring firm.
Capital structure of the acquiring firm.
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Attitude of Management
Friendly merger: Offer made through the targets board Hostile merger: Offer made directly to the target
of directors shareholders. Examples are mentioned below

Approach target management.

Proxy Fight
Enter into merger discussions.
A proxy fight is an attempt by those not in control of a business to use the proxy
method of voting to obtain a sufficient number of shareholder votes to gain control
of the board of directors
Perform due diligence.

Enter into a definitive merger agreement. Bear Hug

A bear hug is an acquisition strategy where the acquirer makes an offer to buy the
shares of the target company at a price that is clearly higher than what the target is
Shareholders and regulators approve. currently worth

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Steps taken to avoid takeover
Pre-Offer Takeover Defense Mechanisms Post-Offer Takeover Defense Mechanisms

Poison pills (flip-in pill and flip-over pill) Just say no defense

Poison puts Litigation

Incorporation in a state with restrictive takeover laws Greenmail

Staggered board of directors Share repurchase

Restricted voting rights Leveraged recapitalization

Supermajority voting provisions Crown jewels defenses

Fair price amendments Pac-Man defense

Golden parachutes White knight defense

White squire defense

It is expected that the students will do their own research to know about each of the defense mechanisms to avoid
takeover.

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19
Valuation Basics
A Primer
Discounted Cash Flow (DCF)
In simple terms, discounted cash flow tries to work out the value today, based
on projections of all of the cash that it could make available to investors in the
future.
It is described as "discounted" cash flow because of the principle of "time value
of money" (i.e. cash in the future is worth less than cash today)
The DCF method is forward-looking and depends more on future expectations
than historical results
Best method to find out the intrinsic value of the company
DCF is one of the key methods used in investment banks for valuation
It is imperative for you to know the basics on DCF to be able to crack the
interview

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 How is DCF Calculated?
Value of Firm = EV (Enterprise Value) = Equity Value + Net Debt
Net Debt = ST and LT loans Operating Cash Liquid and short term investments
Steps in DCF Calculation
Estimate the discount rate also know as WACC i.e weighted average cost of
capital

Estimate the future earnings and cash flows on the firm (FCFF) being valued,
generally by estimating an expected growth rate in earnings.

Estimate the terminal growth rate of the firm and estimate terminal Value

Discount the cash flows to the present day

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 How is DCF Calculated?
Present Value of FCFF :-

For obtaining a further detailed understanding into how each item is calculated in
FCFF, kindly refer to the document below :-
Double click on icon

Link will not work in slideshow mode

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 Comparable Company Analysis
Select Comparable Companies
Publicly traded companies that are similar to the subject company
Same or similar industry

Calculate Relative Value Measures

Enterprise value multiples EV/EBITDA, EV/Sales
Price multiples P/E, P/BV

Apply Metrics to Target

Judgment needed to select appropriate metric

Estimate Takeover Price

Takeover premium added

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 Example: Comparable Company Analysis
Suppose an analyst has gathered the following information on the target
company, the XYZ Company:
XYZ Company Average of Comparables
Earnings $10 million P/E of comparables 30 times
Cash flow $12 million P/CF of comparables 25 times
Book value of equity $50 million P/BV of comparables 2 times
Sales $100 million P/S of comparables 2.5 times

P/E Price/earnings, P/CF Price/cash flow, P/BV Price/ book value, P/S
Price/ sales
If the typical takeover premium is 20%, what is the XYZ Companys value in a
merger using the comparable company approach?
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 Example: Comparable Company Analysis
Assuming that the average of the values from the different multiples is
most appropriate: Comparables Estimated Stock
Multiples Value
Earnings $10 million 30 $300 million
Cash flow $12 million 25 $300 million
Book value of equity $50 million 2 $100 million
Sales $100 million 2.5 $250 million
Average = $237.5 million

Estimated takeover price of the XYZ Company = $237.5 million 1.2 = $285 million

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 Comparable Company Analysis
Advantages
Provides reasonable estimate of the target companys value
Readily available inputs
Estimates based on markets value of company attributes
Disadvantages
Sensitive to market mispricing
Sensitive to estimate of the takeover premium, and historical premiums may
not be accurate to apply to subsequent mergers
Does not consider specific changes that may be made in the target post-
merger

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 Comparable Transaction Analysis

Collect Information
on Recent Takeover Calculate Multiples Estimate Takeover
Transactions of for Comparable Value Based on
Comparable transactions Multiples
Companies

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 Example: Comparable
Transaction Analysis
Suppose an analyst has gathered the following information on the target
company, the MNO Company:

Average of Multiples of
MNO Company Comparable Transactions
Earnings $10 million P/E of comparables 15 times
Cash flow $12 million P/CF of comparables 20 times
Book value of equity $50 million P/BV of comparables 5 times
Sales $100 million P/S of comparables 3 times

Estimate the value of the MNO Company using the comparable transaction analysis,
giving the cash flow multiple 70% and the other methods 10% each.

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 Example: Comparable
Transaction Analysis
Comparables
Transaction Estimated Stock
Multiples Value
Earnings $10 million 15 $150 million
Cash flow $12 million 20 $240 million
Book value of equity $50 million 5 $250 million
Sales $100 million 3 $300 million

Value of MNO = 0.7 $240 + 0.1 $150 + 0.1 $250 + 0.1 $300

Value = $238 million

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Comparable Transaction Analysis
Advantages
Does not require specific estimation of a takeover premium
Based on recent market transactions, so information is current and observed
Reduces litigation risk
Disadvantages
Depends on takeover transactions being correct valuations
There may not be sufficient transactions to observe the valuations
Does not include value of changes to be made in target

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Valuation Summary i.e Football Field
After all types of valuations are done, they are represented graphically through the football field
Foot ball field gives details of the range of company valuation based on different valuation methods

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All the best for Summers

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