Initial Public Offerings – An inside view E-Book

Rolf J. Daxhammer

• Herausgeber: UVK
• Kategorie: Fachliteratur
• Sprache: Englisch
• Veröffentlichungsjahr: 2017

Seitenzahl: 441

Beschreibung

In a corporations financial life going public by means of an IPO is probably the single most important decision. It turns a private company into a public one. Our book will provide an inside view of the IPO process. On the one hand, it draws on the insights of an experienced investment banker, who has gone through numerous IPO transactions. On the other hand, it relates the story of an actual IPO through the eyes of a Chief Executive Officer who has taken two of his companies public. This unique double perspective is our books defining feature. We do not discuss initial public offerings in a textbook style fashion. What we would like to bring out is a more comprehensive portrayal of a once-in-a-lifetime event for most companies and their management, alike.

Leseprobe

Preface

In a corporation’s financial life “going public” by means of an IPO is probably the single most important decision. It turns a private company into a public one. A public company opens itself to the eyes of potential investors in financial markets. Thus, it improves its access to equity capital for funding promising investments, but it pays by providing information for investors’ scrutiny and complying with the rules of the capital markets and its regulators.

Our book will provide an inside view of the IPO process. On the one hand, it draws on the insights of an experienced investment banker, who has gone through numerous IPO transactions. On the other hand, it relates the story of an actual IPO through the eyes of a Chief Executive Officer who has taken two of his companies public.

This unique double perspective is our book’s defining feature. We do not discuss initial public offerings in a textbook style fashion. What we would like to bring out is a more comprehensive portrayal of a “once-in-a-lifetime” event for most companies and their management, alike. As such, it does require some knowledge of basic financial concepts, which will be introduced in the first part of the book. Readers with a solid corporate finance background and some knowledge about investment banking services may safely skip chapters 2 and 3 heading straight into “where the beef is” in parts 2 and 3 after a short warm up/refresher in chapter 1.

“Initial Public Offerings” should be worth reading for the senior management of a company contemplating an initial public offering. It gives students of corporate finance a real life, flesh and blood perspective on their textbook chapters on IPOs. In addition, it will give the interested public a solid introduction to one of the most fascinating phenomena in today’s financial markets.

Such a comprehensive endeavor would not have been possible without the aid of colleagues and friends who have helped us along the way and who we would like to thank cordially:

Barbora Moring and Sarah Steece, experienced capital markets lawyers by profession, investing substantial time and effort in comprehensive reviews and contributions to certain sections of this book.

The teams at epigenomics and Curetis without whom these two IPOs would have been impossible as well as all involved bankers, lawyers, auditors, PR and IR firms, and all other advisors, boards and shareholders, without whose unwavering support such deals would not have been completed successfully.

And, finally yet importantly, we would like to thank André Binanzer and Alexander Schmitz for their support and input into chapters one to three. André was also instrumental in bringing the three parts together into a coherent manuscript.

Rolf Daxhammer

Andreas Resch

Oliver Schacht

About the authors

Prof. Dr. Rolf J. Daxhammer

Prof. Daxhammer joined the full-time faculty of ESB Business School, Reutlingen University in 2000 after almost nine years of work experience in the (investment) banking industry; in which he served in various functions in Capital Markets in Zurich, New York and London. Since 2005 he has been gathering experience as external adviser in numerous IPO-related projects (especially in questions of valuation). His research interests, besides capital markets, include behavioral finance and financial market stability/regulation. He holds a doctorate from the University of Hohenheim in Germany and an MBA from the McCombs School of Business at the University of Texas, Austin.

Andreas Resch

Andreas Resch is an investment banking professional with more than 17 years of experience in corporate finance. To date, he has helped corporate clients raising significant amounts of debt and equity capital (incl. many IPOs). Moreover, he has advised on numerous M&A transactions, primarily in an international context. Andreas is a Managing Director at Commerzbank where he leads the Consumer & Retail sector team within the firm’s Corporate Clients business segment. He started his career in finance by joining Citigroup’s investment banking division in the year 2000, immediately following his graduation from the German-American exchange program of ESB Business School, Reutlingen University with Northeastern University in Boston.

Oliver Schacht, PhD

Oliver Schacht, PhD, is a serial entrepreneur, CEO and CFO with two successful IPOs and many capital market transactions executed. Following three years with Mercer Management Consulting and then thirteen years with cancer diagnostics company Epigenomics, Oliver has been CEO of Curetis (infectious disease diagnostics) since 2011. He has been a co-founder of several additional start-ups in Germany and the US. Oliver obtained his Diploma in European Business Administration at the ESB Business School, Reutlingen University (GB-link with Middlesex University, London) as well as an MPhil. and PhD at the University of Cambridge (UK).

Contents

Preface

About the authors

List of Tables and Figures

Abbreviations

Part 1: Initial Public Offering (IPO) – a theoretical perspective

1 Corporate Finance – an overview

1.1 Equity versus debt

1.1.1 Why capital is needed

1.1.2 Types of capital

1.1.3 Characteristics of debt and equity capital

1.2 Where the money comes from

1.2.1 Internal and external financing and sources of capital

1.2.2 Economic functions of financial markets

1.2.3 Transformation task

1.3 Commercial Banking versus Investment Banking

1.3.1 Institutional set-up of Commercial Banking vs. Investment Banking

1.3.2 Services offered in Investment Banking

1.3.3 IPO as part of Investment Banking services

1.3.4 Investment Banking in the US and Europe

1.4 The global IPO market and its drivers

1.4.1 Overview of international IPO activity

1.4.2 Asia

1.4.3 US

1.4.4 Europe

1.4.5 Future Prospects

2 What Investment Banks do in an IPO

2.1 Advice

2.2 Underwriting

2.3 Distribution

2.4 Post-IPO

3 Value – an elusive concept

3.1 Basic valuation concepts

3.1.1 Asset-based Approach

3.1.2 Combined valuation methods

3.1.3 Holistic valuation approaches

3.2 Discounted cash flow valuation

3.2.1 Estimating discount rates

3.2.2 Measuring cash flows

3.2.3 Forecasting cash flows

3.2.4 Estimation of terminal value

3.3 Relative valuation

3.3.1 Peer group

3.3.2 Types of multiples

3.3.3 Principles of relative valuation

Part 2: IPO – what does it really mean for a company?

4 Money, money, money

4.1 Access to public equity capital markets

4.2 Capital structuring

4.3 Offer structure: who sells how much stock at what price to whom?

4.4 Use of proceeds (if any…)

4.5 The real cost of capital in an IPO – fees & more

5 A big, important project

5.1 Too many cooks?

5.2 Best laid plans

5.3 Timing is everything

5.4 Once in a lifetime experience (except for some…)

6 Public market readiness essentials

6.1 Corporate governance and compliance

6.2 Management information & reporting systems

6.3 Planning and ability to deliver on promises

6.4 The Equity Story – giving a share a life of its own

7 Public company status implications – forever!?

7.1 Media attention…there is no off the record

7.2 Disclosure obligations

7.3 Investor cheer & scrutiny & headaches

7.4 Exit route “take private”

Part 3: The Curetis IPO – a European success story

8 From “Never again” to “Yes we can”

8.1 The epigenomics IPO and its aftermath

8.2 Considerations for Curetis when joining

8.3 Growing Curetis and strategic options

8.4 Change of heart, change of mind

9 Pre-kick-off preparations

9.1 IFRS conversion and audits

9.2 Non-deal roadshow, pilot fishing and test the waters

9.3 Syndicate selection symphony

9.4 Advisors and more

10 Project “Cactus” – memorable milestones

10.1 Kick-off meeting

10.2 Prospectus drafting and the AFM

10.3 Due diligence delirium

10.4 Analysts briefing and pre-IPO research 2015 vs. 2004

10.5 Price, place and packaging

11 Blog from the IPO road show

11.1 Start it off in the BeNeLux and France

11.2 From London via Frankfurt to the USA

11.3 The finish line in sight in London and Switzerland

11.4 Roller coaster and the last 24 hours – build your own book

11.5 Deal is done, let’s deal with it

12 IPO aftermath and “being public” lessons learned

12.1 First day(s) of trading

12.2 The quiet period

12.3 Corporate governance and compliance mania

12.4 Starting the IR song and dance

12.5 Outlook (2016 and beyond), lock-up expiry and growth

Bibliography

List of Tables and Figures

Exhibits

Exhibit 1: Illustration of the main financing options

Exhibit 2: Commercial vs. Investment Banking

Exhibit 3: Global IPO activity by number & volume raised (2008 – 2016)

Source: Own presentation based on EY, 2016

Exhibit 4: Triggering events for financial valuations

Source: Own presentation based on Ernst et al., 2012, p. 1

Exhibit 5: Classification of valuation methods in German literature

Source: Own presentation based on Ernst et al., 2012, p. 2

Exhibit 6: Overview of equity financing alternatives

Exhibit 7: Overview of key parties involved in an IPO

Exhibit 8: Schematic examples for banking syndicates – large vs. small

Exhibit 9: Illustrative high-level IPO timeline

Exhibit 10: Volatility vs. global IPO activity

Source: PricewaterhouseCoopers, 2016

Exhibit 11: Illustration of one-tier board vs. two-tier board structure

Exhibit 12: Shareholder returns – capital appreciation vs. dividend yield

Source: McKinsey & Company, MSCI, own analysis

Exhibit 13: Epigenomics Stock Price Chart 2004-2017

Source: Finanznachrichten, 2017

Exhibit 14: This Lucky Penny Was First Funds Raised

Exhibit 15: Paris Roadshow in Style

Exhibit 16: Cure Post IPO Stock Price

Source: Enternext, 2017

Exhibit 17: CURE Post IPO Stock Price

Source: Enternext, 2017

Exhibit 18: CURE Post IPO Stock Price

Source: Enternext, 2017

Tables

Table 1: League tables: Global Equity IPO for FY16

Source: Bloomberg, 2017

Table 2: Yield spread in basis points over US Treasuries by bond rating

Source: Koller et al., 2010, p. 263

Abbreviations

Abbreviation

Meaning

ABS

–

Asset-Backed Securities

AFM

–

Autoriteit Financiële Markten (Dutch Authority for the Financial Markets)

am

–

ante meridiem

approx.

–

approximately

APV

–

Adjusted Present Value

BaFin

–

Bundesanstalt für Finanzdienstleistungsaufsicht (German Federal Financial Supervisory Authority)

BeNeLux

–

Belgium, The Netherlands & Luxembourg (geographic region)

BMWi

–

Bundesministerium für Wirtschaft und Energie (German Federal Ministry for Economic Affairs and Energy)

c.

–

circa

CAPEX

–

Capital Expenditures

CAPM

–

Capital Asset Pricing Model

CEO

–

Chief Executive Officer

CET

–

Central European Time

CE-IVD

–

Certificat Europeen for In Vitro Diagnostics

cf.

–

confer – compared to

CFO

–

Chief Financial Officer

COO

–

Chief Operating Officer

CTO

–

Chief Technology Officer

CURE

–

Curetis NV (stock ticker)

CYA

–

‘Cover Your Ass’

DACH

–

Germany, Austria & Switzerland (geographic region)

DCF

–

Discounted Cash Flow

D&O insurance

–

Directors and Officers Liability insurance

DRG

–

Diagnostics Related Groups

DVD

–

Digital Versatile Disc (digital optical disc storage format)

e. g.

–

exemplum gratia – for example

EBIT

–

Earnings Before Interest & Taxes (operating income)

EBITDA

–

Earnings Before Interest, Taxes, Depreciation & Amortization

ECM

–

Equity Capital Markets (department within investment banks)

EMEA

–

Europe, Middle East and Africa

etc.

–

et cetera

EU

–

European Union

EUR

–

Euro (currency)

EURIBOR

–

Euro Interbank Offered Rate

EGC

–

Eligible Growth Company (term defined by JOBS Act)

EV

–

Enterprise Value

FCF

–

Free Cash Flow

FDA

–

Food and Drug Administration (USA)

FSE

–

Frankfurt Stock Exchange

FSMA

–

Financial Services and Markets Authority (Belgium)

GAAP

–

Generally Accepted Accounting Principles

HGB

–

Handelsgesetzbuch (German GAAP)

HP

–

Hewlett Packard Enterprise

HR

–

Human Resources (department / function)

i. a.

–

inter alia – amongst others

i.e.

–

id est – that is

IAS

–

International Accounting Standards

IBD

–

Investment Banking Division (department within investment banks)

IFRS

–

International Financial Reporting Standards

IP

–

Intellectual Property

IPO

–

Initial Public Offering

IR

–

Investor Relations

IRR

–

Internal Rate of Return

ISO

–

International Organization for Standardization

ITF

–

Intention to Float

IVD

–

In Vitro Diagnostics

JOBS Act

–

Jumpstart Our Business Startups Act (US)

KfW

–

Kreditanstalt für Wiederaufbau (German Federal Banking institution)

KISS

–

Keep it Short and Simple

KPI

–

Key Performance Indicator

LIBOR

–

London Interbank Offered Rate

LSE

–

London Stock Exchange

MDx

–

Molecular Diagnostics

M&A

–

Mergers & Acquisitions

MSCI

–

MSCI Inc. (provider of investment decision support tools)

NAV

–

Net Asset Value

NASDAQ

–

National Association of Securities Dealers Automated Quotation (stock exchange in the US)

NPV

–

Net Present Value

NYSE

–

New York Stock Exchange

OTC

–

Over-the-counter

p. a.

–

per annum – per year

PBV

–

Price-to-Book Value (valuation multiple)

P&L

–

Profit and Loss statement

PE

–

Private Equity

PIPE

–

Private Investment in Public Equity

PoA

–

Power of Attorney

PR

–

Public Relations

Q&A

–

Questions & Answers

QIB

–

Qualified Institutional Buyers (term defined by the US Securities Act)

RBC

–

Royal Bank of Canada

R&D

–

Research and Development

ROIC

–

Return on Invested Capital

RONIC

–

Return on New Invested Capital

SEC

–

Securities and Exchange Commission (US)

SEO

–

Seasoned Equity Offering

SME

–

Small and Medium-sized Enterprise

SPO

–

Supplementary Public Offering

telco

–

Telephone conference

TV

–

Television

UK

–

United Kingdom

UKLA

–

United Kingdom Listing Authority

US

–

United States

US$

–

US Dollar (currency)

USA

–

United States of America

USP

–

Unique Selling Proposition

VAT

–

Value-added Tax

VC

–

Venture Capital

vs.

–

versus

WACC

–

Weighted Average Cost of Capital

WYSIWYG

–

What You See Is What You Get

YTM

–

Yield-To-Maturity

Part 1: Initial Public Offering (IPO) – a theoretical perspective

The first part of this book provides a theoretical framework for the IPO-related concepts addressed during an IPO project.

Chapter 1 outlines the basic corporate finance concepts necessary to understand the significance of an IPO for raising equity capital in financial markets. These include the different financing types and sources: equity vs. debt, internal vs. external. Organizational and conceptual differences between investment and commercial banking are addressed, as well. Moreover, past and current developments in IPO markets are described and put into a practical perspective.

Chapter 2 takes a closer look at investment banking’s internal processes and explains investment banks’ role during an IPO including the individual tasks performed by them. Thus, this chapter addresses the main tasks carried out by investment banks before, during and after an IPO.

Finally, Chapter 3 approaches the difficult task of finding a value for an IPO candidate company from a theoretical perspective. As will be seen, value can differ substantially according to the valuation method used. And there is not one single “correct” valuation method, leaving a lot of room for discussions and arguments in an actual IPO process.

1 Corporate Finance – an overview

1.1 Equity versus debt

This chapter provides a brief outlook on the most common financing means used by companies: equity and debt. It explains the reasons why companies need funding and what financing options companies can choose from. A brief description of the main players in the funding arena will be provided and a brief summary of the current IPO market intends to give a real-life perspective on the theoretical approach.

1.1.1 Why capital is needed

According to widespread economic understanding, only those companies which provide products or services in demand are successful on the long run. Therefore, companies need (innovative) products or services that satisfy customer needs in order to be able to survive in the market. The research and development as well as the production process for these goods and services require resources (also known as “assets”). These assets can either be of tangible (i.e. physical) or intangible nature ranging from machines and buildings to more specific forms like patents. They are acquired through financial activities, commonly referred to as “investments”. However, no predetermined financing formula exists as it is common practice to use a trial-and-error process to determine the company and sector specific investment practice. For example, the pharmaceutical industry is known for long testing procedures and approval processes for the national health agencies (e.g. Federal Drug Administration - USA, European Medicines Agency - Europe) whereas other companies’ main capital need rests on the establishment of production facilities or (international) distribution channels.

1.1.2 Types of capital

Generally, companies have two major financing options: equity or debt.

Equity in accounting terms presents the residual value (i.e. the difference) between assets and liabilities. From a more company-related approach equity describes its monetary “value” for the owner(s) and their claim on future profits of the company. The different concepts of value and price will be discussed in chapter 3. In this sense, the claim on a prospective profit distribution is sliced into a certain number of pieces that can be traded publicly (called stocks or shares). An IPO is an equity financing method as shares (and therefore equity instruments) are offered for the first time to the investing public. Equity investors are usually compensated for their engagement through dividend payments and/ or through an increase in stock value.

Debt capital is based on a contractual relationship between an investor (“creditor”/lender”) and a “debtor” or “borrower” which lacks funding. The debtor compensates the lender for not being able to use the capital himself by paying a certain interest rate on the borrowed capital. In economics, this concept is known as “opportunity cost”. In the personal realm, debt comes in the form of credit card debt or mortgage loans (special type of loan used to finance real estate). However, corporations also approach financial markets in order to issue corporate debt obligations (“corporate bonds”). The respective interest rate is determined by the pre-determined periodic coupon payments and the face value which will be returned at maturity.

There are also funding instruments in the form of a mixture between debt and equity. They are commonly known as “mezzanine” or “hybrid” capital. Depending on the prevalent characteristics, they are clustered into debt-like and equity-like mezzanine instruments. Mezzanine debt instruments often include options, warrants or other rights. Convertible bonds are a typical example for mezzanine instruments.1 They pay a fixed coupon and promise the payback of the face value, while giving the investor the choice to exchange the bonds into shares.

1.1.3 Characteristics of debt and equity capital

Debt and equity financing differ substantially. An IPO is considered to be equity financing since it is the first time that a company offers its shares to the public. This paragraph discusses the main differences between debt and equity funding for both, the investors and the issuing company.

With the purchase of equity instruments (e.g. shares of a company) an investor becomes a partial owner of a company. Therefore, depending on the equity form the shareholder is at least liable with the entire capital invested. In case of a non-public (i.e. private) company with unlimited liability an owner commits also all personal wealth in case of filing for bankruptcy.2 In contrast, debt financing involves no liability and the maximum loss can only amount to the lent capital.

Shareholders, thus partial owners of the company (i.e. equity investors) have also claims on the company’s profits (and liabilities in case of losses). Therefore, there is no pre-determined compensation ceiling or floor limiting compensation. Debt is compensated by a fixed interest rate or quasi-fixed interest rate, known as “floating interest rate” (the reference points depend on the specific debt financing instruments e.g. mortgage loans are usually LIBOR or EURIBOR based). Hence, no claims on profits exist for debt instruments. However, in contrast to equity, the pre-determined conditions specified in the contract (“loan agreement”) limit the claims on debtors.

In case of a bankruptcy, shareholders can only make a claim on the residual (i.e. remaining) assets after all other third-party liabilities have been compensated. Debtors hold a superior position as their claims are served before those of the shareholders and therefore often retrieve at least part of their invested money. Usually, there is a certain hierarchy when serving debtors according to the issuing date and certain clauses in the issuance contract. Therefore, debt securities are classified as senior and junior-ranked securities.

To a partial owner, equity instruments give (at least theoretically) the right to administrate the company. Therefore, public companies hold annual shareholder meetings, chaired by the company’s management board, where each shareholder can exercise his voting rights. As debtors have only a contractual relationship with the company, no direct involvement in corporate matters is sought.

Another differentiating factor relates to time. Equity financing is unlimited as ownership does not terminate at a certain point in time. Clearly, that relationship ends with the sale of the shares or bankruptcy of the company. The debt agreement forms the legal basis of a debt instrument and specifies special features. In its purest form, it spells out a framework with the most basic conditions including the repayment schedule, time horizon, interest rate and calculation form (e.g. annuity, bullet loan, etc.).

The tax treatment of debt and equity differs, as well: Whereas payouts for equity instruments (i.e. dividends) are subject to taxation (the precise rates vary by national jurisdiction), interest payments are tax deductible for the company.

1.2 Where the money comes from

1.2.1 Internal and external financing and sources of capital

In the previous chapter, financial instruments were grouped according to legal differences (equity and debt). Another criterion how funding opportunities can be clustered is the origin of the capital: A company can finance its investment activities internally or it can approach external (third) parties for financing. Therefore, the entirety of financing options open to companies follows a 2x2 matrix which is presented below.

Exhibit 1: Illustration of the main financing options

Source: Own presentation

In “internal” financing, no capital flows from external third parties to the company, and funding is therefore generated by the company’s activities itself. The most intuitive form is the sale of assets at a profit (e.g. sale of produced goods, buildings or company cars etc.). Other more sophisticated forms include reserves. Reserves can be hidden (not reflecting the asset’s value on the balance sheet) and detectable according to some Generally Accepted Accounting Principles (e.g. German GAAP – HGB and to a lesser extent IFRS). Even though IFRS is based on a “fair value” approach meaning that balance sheet positions are recorded at market values, there exist a myriad of balance sheet positions where hidden reserves are possible.

The most prominent example for observable reserves are retained earnings which result from previous years’ profits that have not been distributed to shareholders.

Provisions are another form of self-financing (debt in this case). Provisions are booked when a given periods business activities can be expected to cause a future cash outflow with the exact timing and/ or the amount of the outflow unknown.

As noted before, companies generally cannot finance their entire investment activities through internal sources. Therefore, third parties providing capital are needed. External financing refers to the fact that money flows from external parties to the company. Main players in a company’s early life include private investors such as family and friends, business angels or high net worth individuals. “Family and friends” financing is often used for start-up companies that have no access to more sophisticated forms of finance or bank loans (due to the high risk associated with the repayment or the lack of collateral). Often, Business Angels are former start-up founders who have turned into wealthy individuals.3 They acquire stakes of companies and often take on an advising role in a specific sector (usually based on experience and interest). High net worth individuals tend to manage their investments through so-called “family-offices”, in which sometimes an entire family-clan is represented.

Another key provider of external financing is the financial intermediary industry. It includes banks, pension funds, investment funds and insurance companies. Banks, for example, provide loans and therefore contribute to a company’s financing. Pension funds (e.g. Charles Schwab) administer and accumulate large amounts of private capital in retirement plans and distribute it to different investment opportunities. Investment funds, including hedge funds and private equity funds are also a prime source of equity and debt capital. Insurance providers receive periodically payments by their customers. However, cash inflows and outflows (in case of an insurance claim) do not occur simultaneously. Hence, in order to maximize profits, insurance providers invest the available capital.

Altogether, financial markets provide access to an exchange platform for capital seeking companies. Stock markets (exchanges) and over-the-counter (OTC) markets which comprise less strictly regulated financial markets, represent the main funding means in financial markets on the equity side. Finally worth mentoning is crowd investing, even though it is still in an infant stage. It channels usually small amounts of capital from investors to companies through internet platforms.

1.2.2 Economic functions of financial markets

Financial markets are essential for the entire economic system because of the functions they perform to facilitate the link between savings and real investments in an economy.

Price discovery is the result of market participants’ supply of and demand for capital. Demand for capital, thus supply of financial assets stems from companies or other institutions in need of funding. With reference to the subject of this book, companies carrying out an IPO transaction increase the supply of equity instruments. The demand side consists of investors with a funding surplus trying to invest in assets which meet their particular rate of return and/or risk profiles.

In financial markets, liquidity makes sure that investors can trade financial assets at any time they wish to. This type of flexibility allows investors to react to new information on company and environment related issues that may influence their assessment of an investment’s value.

Lastly, financial markets can reduce transaction costs for market participants and are, therefore, considered to be an efficient way of capital allocation. Transaction costs include a myriad of different costs the market participants may incur. The search and information costs, for example, are related to the expenses for evaluating the potential investment and/ or retrieving relevant information needed for the investment decision.

1.2.3 Transformation task

As an illustration for the transformation tasks one can use commercial banking activities in a “traditional” bank (e.g. J.P. Morgan Chase, Commerzbank, etc.) where a banking clerk checks the references and personal history to accept or reject a loan request. The sole focus of commercial banking lies on the distribution of credit related products, i.e. loans. A commercial banks’ customer base is usually well diversified ranging from individuals, SMEs, to major enterprises also including the governmental or municipal sector. Thus, commercial banks carry out the following transformation tasks:

Maturity transformation

Time horizons of investors and borrowers usually differ. Some investors tend to invest only for a certain, often short period of time, whereas debtors need more time to redeem the loan. This process of converting assets into different termed liabilities is called “maturity transformation”. Deposits are released at other times than emitted loans are redeemed. Therefore, commercial banks match the time horizon of savers and borrowers. This is possible because many savers and borrowers exist that can compensate for timing differences.

Size transformation

The size transformation is sometimes also referred to as “collection and parceling”. Financial markets draw on small amounts of money by a large investor base (“collection”) and then redistribute the overall funds into the particular funding amount (“parceling”) required by borrowers.

Risk transformation

As investors tend to be risk-averse in different degrees, the invested capital should reflect that risk attitude accordingly and the incurred risk has to be managed. However, borrowers take risk and invest in risky undertakings with no certainty of the outcome. So, risk has to be allocated in different degrees to different investors. In commercial banking, investor’s risk can be diversified and therefore be reduced by splitting the overall invested capital and by investing only small amounts of money into specific financial assets.

Investment banking, on the other hand includes various financial services organizing the direct interaction between capital providers (investors) and capital users (companies). Investment banks’ customers on the capital supply side are mainly corporate and institutional investors. Their main task is to serve as a financial intermediary and to organize transactions in the corresponding financial market. We will discuss the differences between commercial banking and investment banking in more detail in the next chapter.

1.3 Commercial Banking versus Investment Banking

The previous chapter already explained the theoretical concept and differences between commercial and investment banking. The focus of this chapter lies on providing a more detailed view on processes and organizational structures of both approaches.

Exhibit 2: Commercial vs. Investment Banking

Source: Own presentation

1.3.1 Institutional set-up of Commercial Banking vs. Investment Banking

Investment banks are usually structured along the services offered. Core investment banking activities include financial markets (sales and trading) and the corporate finance (issuing securities and M&A) realm. Different departments often follow a common logic. The front office plays an essential role as it is closely linked to the revenue generating business. The sales and trading division buys and sells financial products in the market. Sales advises customers (i.e. the issuance) of various financial products according to their financing needs. Structuring includes numerical tasks to originate complex financial products (e.g. derivatives or ABS which have gained a wide media attention during the financial crisis). A third division includes the research by financial analysts often publishing so called research reports (giving a buy, sell or hold recommendation). The recommendations are usually based on primary or fundamental research. The middle office is responsible for the internal procedures and strategy development as well as the efficient treasury handling. Back offices need to make sure that all processes run smoothly and that all transactions are completed correctly. It involves a large portion of computing infrastructure mainly through technological advances or the development of electronical trading schemes.

Commercial banks are also divided into three main areas of business activity. They pool deposits from various individuals who want to save part of their earnings. This task is related to all areas of wealth management even though the main focus lies on saving accounts, especially in Germany. A second task relates to the lending activity to companies or individuals in need of financial resources. A third pillar consists in providing an adequate infrastructure for payment transactions, foreign exchange activity and other capital transfers. These institutions often use a high leverage ratio with little equity. After the financial crisis, regulators required a higher equity base and passed laws to strengthen commercial banks’ capital base (the most renowned regulation efforts are Basel II and Basel III).

Many original commercial banks have diversified into investment banking over the last twenty to thirty years and now include also an investment banking division (e.g. Deutsche Bank). Financial institutions that comprise both commercial and investment banking activity are called universal banks. In the past, regulation in some regions (e.g. the US jurisdiction until 1999) restricted universal banking activity, thus, separating investment banks from commercial banks not only functionally but also institutionally. In the wake of the latest financial market crisis, this separation is discussed again to reduce the vulnerability of the financial system.

1.3.2 Services offered in Investment Banking

The financial market related services investment banks provide are various and include advising roles which can be illustrated along the broad spectrum of financial products, covering the entire company life cycle. It begins with a start-up financing including exit options for private equity and venture capital firms by carrying out an IPO. Once a company’s shares are publicly traded (“post IPO”) secondary equity offerings can also be considered. However, not only equity offerings are undertaken by investment banks but also publicly traded debt offerings can be originated by them. During the IPO process the concept of underwriting is closely linked to investment banking activities which will be discussed in chapter 2. Syndication is another service provided by investment banks. It structures debt obligations into other financial and tradable products (ABS). The sales and trading handles various tasks related to transactions in financial markets. Among these, in brokerage services money is invested on behalf of investors whereas proprietary trading is often related to profit seeking activities by investing the investment banks own capital.4

1.3.3 IPO as part of Investment Banking services

As explained earlier, during the IPO process investment banks bring together investors and companies in need of capital.

In the IPO process, investment banks assist companies with advice which will be explained in greater detail in chapter 2.2. Shares are offered to the public investor base for the first time (“Initial public offering”). Therefore, investment banks can advise prospective IPO companies on questions related to if, when and how an IPO should be performed.

During the IPO, underwriting tasks are carried out by investment banks through which various risk positions are shifted from the issuing company to the investment bank(s). During the process, investment banks offer their capital raising clients business contacts and schedule appointments with financial advisors or directly with investors (“roadshow”).

1.3.4 Investment Banking in the US and Europe

The historical development of modern investment banks can be traced back to America in the 1920s when commercial banks acquired stockbroker institutions because after WWI funding was less expensive in the stock market. After some crises and subsequent regulation, globalization after WWII opened the door to new business activities such as currency trading and trading in other financial instruments (e.g. derivatives).

In Europe, universal banks have been the predominant banking model since the early 19th century. The various tasks were mostly carried out on a local (i.e. national) level. England was and still is considered the financial center of Europe being the headquarter of most investment banks. The Brexit referendum and the prospect of Britain leaving the European Union, however, have led many investment banks to reconsider relocation at least in parts to the European Union.

The American origins of modern investment banking can still be observed in today’s markets as American investment banks tend to play a dominant role even in European markets. This conclusion can also be reached when regarding the investment banking IPO business environment. More than half of the represented investment banks in the Top 10, ranked by market share, are of Anglo-Saxon origin.

Table 1: League tables: Global Equity IPO for FY16

RankFirmMarket share in %Volume in US$ bn1JP Morgan6.3448.5402Morgan Stanley6.0238.1083Goldman Sachs5.0446.7914Citi4.6776.2965Deutsche Bank4.1045.5256Credit Suisse3.8965.2087Bank of America Merrill Lynch3.2995.0908UBS2.4594.4419Nomura2.4593.31110CITIC Securities Co Ltd1.9802.665

Source: Bloomberg, 2017, p. 7

1.4 The global IPO market and its drivers

This chapter gives a short overview of the historic and current global IPO activities and trends. It analyses regional and local peculiarities in IPO markets and provides a brief outlook on the near future.

1.4.1 Overview of international IPO activity

Exhibit 3 points out that the past eight years were quite volatile with regard to the total number of IPOs and the total volume raised thereby. In the wake of the financial market crisis and the related economic uncertainty, global IPO activity remained at a very low level (PwC, 2009, p. 14). In 2010 however, global IPO markets gained momentum and returned to pre-crisis levels. The rising political and economic risks overshadowed 2011 and caused a major drawback in IPO activity. Central Banks’ decisions to lower interest rates to historical lows stimulated spending which, in turn, boosted the global economy in 2014 (EY, 2014, p. 1). The following two years again were overshadowed by major political and economic instability. Many recent events including the Brexit referendum, presidential elections and ongoing migrant streams led to a higher uncertainty in capital markets and therefore slowed down IPO activity, again.

Exhibit 3: Global IPO activity by number & volume raised (2008 – 2016)

Source: Own presentation based on EY, 2016

It is also instructive to look at the regional distribution of IPO candidates. The People’s Republic of China has played a dominant role in global activity in recent years (EY, 2016, p. 2). The Asian continent accounted for almost 6 out of 10 IPOs worldwide. The following paragraph examines the regional differences that exist throughout the main world regions.

1.4.2 Asia

As mentioned earlier, in recent years Asia has been the main driver of global IPO activity. Especially China accounts for a large portion of IPOs worldwide (331 in China vs. 1004 overall in 2016). IPO activity is channeled by the CSRC (China Securities Regulatory Commission) as many companies waiting for an IPO acceptance are still in the pipeline (740 as of 2016). Most of the activity comes from Chinas three main stock exchanges Hong Kong, Shenzhen and Shanghai.

During the past couple of years, The Communist Party of China began opening its formerly secluded economic policy. As a consequence, many previously state-owned companies were taken public, leading to a steady rise of China-based IPOs. Since these companies tend to show well-developed and proven business models, state-owned IPOs raised larger volumes when going public compared to their entrepreneurial counterparts.

1.4.3 US

Financial sponsors, i.e. Private Equity or Venture Capital companies have driven American IPOs over the last couple of years. Partly due to the world’s Central Banks low interest rate policy, equity markets have risen to high levels. Rising equity markets help financial sponsors due to a more attractive valuation when filing for an IPO. Therefore, many exit strategies of financial sponsors have been delayed in order to make a bet on rising markets. As a consequence, more established and developed companies have gone public.

Popular sectors include technology and health care. Especially the technology sector has drawn a lot of media attention and dominated media coverage. The so-called “unicorns” (Companies whose valuations exceeds US$ 1billion) went or are about to go public. Since American equity analysts have already acquired expertise with technology-based business models, cross listings from European and Asian tech companies in the US are expected for the near future.5

For many years, Nasdaq has been the home for the most prestigious technology companies. The companies listed on Nasdaq include both software and manufacturing related companies such as Apple, Alphabet (the parent company of Google), Microsoft, Facebook, and Amazon.

1.4.4 Europe

UK as the financial center of Europe is facing major issues at this point of time. Political risk associated with the UK referendum to leave the EU lowered IPO activity in overall Europe in 2016. In addition, the upcoming presidential elections in some European countries impede IPOs. The before mentioned uncertainties have a great impact on IPO activities. The significant number of withdrawals and IPO cancelations fall into this context. Another indicator pointing towards this development is the decrease in the volume raised in European IPOs (down by 27% in 2016 compared with 2015).

1.4.5 Future Prospects

As mentioned before, capital markets and especially IPO activity are quite sensitive to market volatility. Therefore, forecasts should be taken with more than only a grain of salt.

Europe’s stock markets have shown very high volatility but have reached record levels in 2017, nevertheless. The current risks however, are not harming global IPO activity since its main driver is Asia. The Chinese authorities (CSRC) have already approved a large number of IPO candidates, which means that the IPO pipeline is quite full. When it comes to deal volume, companies can be divided up into previously state- owned and entrepreneurial companies. Previously state-owned enterprises account for larger volumes raised than their entrepreneurial counterparts.

As Chinese economic policy moves on to more regulated equity markets by initiating long awaited reforms, overseas investor’s confidence might be boosted and more capital inflow and foreign investments are possible.

Potential investors in European equity markets seem to be rather bewildered by current political developments and therefore follow a “Wait-and-see” strategy. Thus, forecasts project a sluggish development with only minor IPO filings for the near future until political issues will have been resolved.

Even though in the short run future prospects are relatively subdued (except for China), projections for the long run are rather optimistic. A study conducted by PwC in 2011 addresses the future development of capital markets by 2025 (PwC, 2011). Whereas past IPO activity was centered on industrial western nations, the authors of the study project a move towards the Asian continent.

The study also suggests that the historical financial centers of the world, London and New York, might be replaced by others. The authors concluded that smaller, regional stock exchanges are continuously challenging them in today’s IPO markets.

A different approach to IPO activity can be observed in indirect IPO motivations. In order to get access to developing markets and to assure local liquidity, established companies were seen building regional hubs by listing on local exchanges in the past (e.g. Prada and Samsonite in Hong Kong).

In summary, major changes are on the horizon over the next couple of years. The geographical perspective will change the IPO environment as current forecasts project global IPO markets to shift towards Asia in both volume raised and number of IPOs. This also means that western IPO markets will lose in global significance. Furthermore, the market structure is expected to change as more established equity markets are challenged by new entrants. As a result, global competition will intensify and a more split market structure is possible. In the past, European markets have already acted correspondingly and merged with former competitors to scale up.

2 What Investment Banks do in an IPO

This chapter presents a basic overview of the role investment banks play during the IPO process.6 We will discuss in more depth the four main functions, investment banks engage in. These, among others, include the advising role for the client on why an IPO (or maybe other equity/ debt instruments) is the most fitting (financing) option with respect to the individual circumstances (see 2.1). Once an IPO is planned, a consortium of investment banks assumes one of the key roles in an IPO: the underwriting task (see 2.2). Responsibilities, duties and tasks vary substantially depending on the specific role given to the investment bank. Then, the client and its advising investment bank allocate the shares according to their specific considerations, expectations and plans (see 2.3). Contractual relationships, however, do not end at the moment the company lists its shares on a public stock exchange for the first time (commonly referred to as the “going public” process). Hence, chapter 2.4 examines bank’s involvement in post IPO activities (“follow-on transactions”).

2.1 Advice

Before a financially motived IPO, a privately-held company first decides on its strategic and operative activities during the periodic planning process. These, among others, can include projects like the development of new products, M&A activity or business expansion. Carrying out these activities requires sufficient financing. As described above investments can be financed by using either equity or debt instruments (or a certain mixture of both, called “mezzanine financing”). For the sake of completeness, it is worth mentioning that there are other types of IPOs in which the financing factor is not dominating. These can be of strategic (e.g. spin-offs, exit options for VCs) and other non-financial nature (e.g. reputation, product marketing or employer attractiveness through offering stock options).

With regard to the prospective size of the IPO, the initial client contact with investment banks tends to differ. If the IPO is expected to raise a large amount of money, many investment banks find it attractive (even though competition can be quite tough) to compete with other rivaling investment banks. Then, those investment banks “apply” to be part of the beauty contest. The following paragraph describes its procedure in more detail. However, if SMEs (e.g. the German “Mittelstand”) intend to raise money, the companies often take the initiative and approach an investment bank to ask for advice. Another option is that the investment banks screen the market and, if they find an appropriate company, try to convince it to carry out an IPO (mainly by showing the advantages of an IPO).

Type of Security

One of the most important responsibilities of a company’s Chief Financial Officer (“CFO”) is the planning of the appropriate capital structure, i.e. the mix between equity and debt. As described in chapter 1.1 both financing options vary in terms of cost and legal consequences. Since this task involves a great deal of risk and requires a wide knowledge and expertise, the financing decision is a challenging task. Since investment banks pool great expertise in financial markets, they offer a wide array of financing related information (e.g. advisory). Those services include, among others, advising the client on what security seems to be the best fit for the company. During its advising activity, the investment bankers get a grasp on the business environment and a more refined view of the company. As investment bankers are constantly screening the market conditions (also known as “investing climate”), they are able to give a sound recommendation on what security may be best suited for the businesses’ needs at the given point of time.

Beauty contest

Once an IPO is chosen as the best option to pursue, the investment banks to accompany the project need to be selected. A beauty contest in the context of an envisioned IPO describes the hiring process of an investment bank as a lead advisor and project manager. Starting with a short presentation (“pitch”) the invited investment banks propose their IPO concept. The pitch includes detailed marketing strategies, strategic positioning of the issue and a sound demand forecast. In these presentations, the invited investment banks discuss the proposed company value and how many shares can be sold in the market at this point of time. In this context, company executives often run into a real dilemma; the best qualified investment bank may not be the one with the highest proposed valuation. Best qualified investment banks gathered a large expertise in the sector (equity research) and show a strong track record of previously executed transactions (tombstones of comparable transactions). Other criteria incorporated in the decision-making process include fees, international presence (offices or branches), reputation and network. In addition, the firm’s main bank is often also invited. Therefore, stable and long-term relationships as well as complementary financial services (e.g. following-on loans) are taken into consideration.

Once all invited investment banks presented their proposals, the issuing company chooses the investment bank it wants to cooperate with for the IPO project. Since resource restrictions apply (time and personnel) and in order to limit risk, the plethora of tasks are distributed among various investment banks. The whole set of tasks include the advising activity (before and during the IPO), marketing and placement activities as well as settlement and risk services (see chapter 2.2). Since many parties collaborate on an IPO the main functions are outlined briefly.

The

Lead manager

is responsible for the successful completion of the IPO process. In large or transnational IPOs, two (but seldom more) investment banks combine their forces to jointly organize the IPO (“Lead manager” & “Co-manager” also referred to as “Joint Lead manager”). In order to relieve management, the lead manager helps the issuing company to coordinate the different tasks and to select the remaining advisors.

The investment bank that collects orders from investors and transcribes them into an orderbook is called the

Bookrunner

. The bookrunner often coincides with the lead manager.

Regional managers

can facilitate the process of placing the offered shares in certain regions. The regional managers act mostly in foreign or very specific market segments and can contribute especially with their knowledge and expertise to the success of the process.

A special type of regional manager is the

selling agent.

The two differ in that the selling agent does not assume any risk. The investment bank only oversees the placement; it collects and passes incoming orders to the bookrunner.

Hence, the chosen investment bank(s) are responsible for a successful placement. After the evaluation, the company asks for the corresponding “Engagement letter” of the top candidates and signs the best fitting proposal.

Time

Timing can be understood in two different ways: the timing in the company’s life cycle and the timing in terms of the projected timeframe.

The advising investment bank intends to organize the process as efficiently as possible. Together with the IPO company, it decides on the timeframe for milestones in order to meet the tight IPO schedule.

As mentioned in chapter 1.4, IPO markets are quite volatile and therefore the so-called “market windows” open and close unexpectedly. Investment banks, therefore try to prepare for a possible IPO opportunity and execute the IPO once the market opens (see Part 3).

Price

Once, the advising investment bank and the company have agreed on the equity financing by issuing shares, pricing of those shares is an important task carried out by the investment bank. The most often applied pricing methods include the open-offer (proposing a fixed price) or the book-building method. Both depend on market demand. As shares represent the partial ownership of a company, the “realistic” stock price reflects the value of a company. Price and value are closely related concepts which will be discussed in chapter 3. During the pricing process, financial analysts prepare complex financial models in order to find the “real value” of a stock (“intrinsic value”) and advise the company on the stock valuation. Variables determining the valuation include quantitative factors (largely concerned with past and projected financial performance of the company, its business sector and the overall economy) and qualitative factors (quality of the management team, proven track record or historical achievements in hitting strategic targets). Depending on investors’ demand for the issued shares, the proposed share price can be under- or overpriced, both leading to adverse consequences for the involved parties (see chapter 2.2). Hence, pricing shares usually is a very delicate task.

Place

The public company to-be, together with its advising investment bank, also consider the stock market the company wants to list its stock on. The default option would be to list the shares on an exchange in the company’s country of origin. However, regulatory requirements may prohibit listing on certain stock exchanges. And many companies decide to sell their shares on a stock market abroad (“foreign exchange listings”). These companies defy the drawbacks such as higher complexity and costs in order to benefit from the advantages. Those benefits might include more liquidity held by foreign investors, the access to more potential investors, higher achieved valuations or specialized markets (e.g. technology-affiliated stock exchanges like Nasdaq in the US.). Other companies also prepare to list on multiple exchanges simultaneously (also known as “dual” or “multiple” listing).

Once the country is chosen, the specific stock exchange needs to be selected as well. An important factor is the reputation of the stock exchange (e.g. NYSE or Börse Frankfurt are globally recognized). As a better reputation is often based on a more transparent and regulated stock exchange, investors’ confidence is higher and can be an advantage for the issuing company. Those listing requirements differ from stock exchange to stock exchange and, therefore, are a crucial decision criterion.

Addressees

During the IPO preparation, investment banks also approach possible investors for participating in the IPO. The process can be organized in a private or a public offering. In a private offering, only a pre-selected group of institutional investors participate in the IPO, whereas in a public offering, the offering is presented to a diverse group of investors.

For the execution of an effective marketing strategy in a public offering, investment banks divide possible IPO subscribers into different target groups (called “tranches”). These mainly comprise institutional and private investors (known as “retail”) as well as company employees. In some countries (e.g. the US), target groups also include international investors.

As jurisdiction differs significantly between countries, no generalization can be made with respect to the ratio of institutional to private investors. However, it plays a major role when pricing shares and defining purchase clauses for the different tranches. The distribution process is discussed in greater depth in chapter 2.3.

What to expect in the IPO preparation

In the pre-IPO phase, the company needs to be analyzed properly. Depending on the IPO readiness of the company, some formal activities need to be undertaken. So, auditors need to approve financial statements (eventually transfer past financial statements to different accounting standards, e.g. IFRS). Often the company needs to be restructured or to be refinanced to obtain a better capital mix. Important documents need to be drafted and approved by all the involved parties (i.e. public authorities, bankers, lawyers and the management team). In this phase, potential investors and the company itself go through a Due Diligence in which the company may also be benchmarked against competitors in the same sector. Special focus is put on the IPO filing papers to national financial authorities (e.g. SEC or BaFin) and the prospectus.