IPOs: Process and Pricing

1
IPOs Process and Pricing

• Presented to
• The Taiwan Stock Exchange
• Gretai Securities Markets
• The China Intangible Asset Valuation Association
• by
• Daniel L. McConaughy, PhD
• Partner, Grobstein, Horwath and Company LLP
• Associate Professor of Finance, California State
  University Northridge
• Dmcconaughy_at_horwathcal.com 818-501-5200
• March 21, 2005

2
IPO IS

• an Initial Public Offering of a companys stock
  to the public
• an orderly sale of shares to the public following
  rules outlined in the Securities Act of 1933 and
  enforced by the SEC
• A mechanism for private companies to sell
  ownership stakes to investors who believe in the
  companies futures
• Purposes
• Growth
• Recapitalization
• Original shareholders diversify

3
BENEFITS of being a Public Company

• Expand and diversify equity base
• Lower cost of capital
• Public exposure and prestige
• Equity-based compensation opportunities for
  attracting and retaining key management and
  employees
• Creation of Currency for acquisitions
• Facilitates other financing opportunities
  equity, convertible debt, cheaper bank loans, etc.

Individuals
Management Venture Capital Funds
Pension Funds
Mutual Funds
Other Institutions
4
COSTS of being a Public Company

• Disclosure requirements
• Scrutiny by and pressure from shareholders and
  security analysts
• Shareholder Relations
• Vulnerability to hostile takeovers
• Corporate governance
• Cultural considerations

5
Private vs. Public Company

• Public Company
• Disclosure
• - Public quarterly SEC filings
• - Detailed review of operating results
• - Quarterly investor calls, easier for
  competition to asses strengths and weaknesses
• Accountability
• - External shareholders
• - Research Analysts
• - Management
• - Board of Directors
• Forecasting
• - Thorough
• - Precise
• - Conservative
• - Must meet or exceed Street expectations
  missing a forecast can result in stock price
  drop

Private Company

• Disclosure
• - Private summary results to shareholders
• - Management accounting
• - Hard for competition to monitor
• Accountability
• - Management
• - Shareholders
• - Board of Directors
• Forecasting
• - Primarily for budgeting
• - Missing budgeted numbers may impact
  bonus payments but does not necessarily weaken a
  companys competitive position or value

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Preparation for IPO

• Understand and fulfill due diligence requirements
• Develop budgeting and reporting processes
• Develop timely reporting of key metrics
• Develop investor relations and communication
  methods to disclose performance changes
• Identify key persons to provide communications to
  investors
• Train investor relations staff for
• - responses to outsider
  inquiries
• - information
  disclosures

7
Follow up after IPO

• Manage investors expectations
• Investor relations activities
• - Conference calls
• - Press releases
• - SEC requirements
• - Ongoing discussions with investors and
  analysts
• Create management credibility
• Ensure responsiveness to changing marketplace

8
Getting Started

• Preliminaries
• Put together Strategic working group
• Devise structure of offering
• Schedule and assign tasks
• Put together Legal Team
• Publicity
• Make sure Accounting Team has credibility and
  expertise

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Getting Started

• Duties
• Hire the Outside Team
• Lead Manager
• Co-mangers
• Issuers counsel
• Underwriters counsel
• Accountants
• Prepare the Internal Team
• Structure
• Strategy
• Due diligence
• Disclosure
• Must be able to work effectively with Outside
  Team

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Getting Started

• Structuring the Offering
• Size
• Number of shares authorized
• Follow-on issues
• Status of mezzanine financing
• - pay in cash
• - give shares
• Review existing shareholders
• Determine lock-up agreements with company,
  principal shareholders, officers, directors
• Underwriter distribution objectives/syndication
• Selection of listing exchange
• Selection of stock symbol
• Use of proceeds

11
Getting Started

• To Do List
• Due diligence making sure things are OK
• Drafting legal documents and regulatory filings
• Audited financials
• Shareholder communications
• Board meetings
• Filing with SEC
• SEC review period
• Roadshow
• Pricing and offering size
• IPO follow up details

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Getting Started

• Legal Considerations
• Outstanding claims
• Loan agreement restrictions or other consents
  needed to offer shares
• Board meetings
• Disclosure of confidential agreements
• Request of confidentiality or treatment of
  confidential information
• Possible lawsuits
• Possible acquisitions, divestitures,
  restructuring, management changes

13
Getting Started

• Investor Relations
• Quiet period
• Industry presentations
• Press releases/other corporate announcements
• Interviews or articles on company to be published

14
Getting Started

• Financial and Accounting Matters
• Prepare historical and pro forma audited
  financial statements
• Identify unusual items requiring advance
  discussion with SEC
• Auditors comfort letter to the underwriter

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Getting Started
Time Line
2 months
1 month
Continuing
2 3 months
Marketing the Issue - Red herrings print and
distribute - Stock Analysts present to
underwriters sales forces - Target key
investors - Create underwriting syndicate -
Presentations to sell-side analyst - Roadshow
presentations - Develop the Book
i.e.,institutional and retail demand
Pricing, Trading and Follow-on Support - Analyze
pricing issues and investor feedback - Determine
allocation to retail institution - Begin
aftermarket trading - Closing details - On-going
research - Investor relations begins and
continues in earnest

• Prior to filing
• - Due diligence
• Valuation
• - Choose co-managers
• - Documentation
• - Positioning
• - File registration statement

• SEC Review
• - Prepare for roadshow
• presentation
• - Respond to SEC
• Comments

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Due Diligence Process

• Corporate Level Company
• History
• Mission statement/vision
• SWOT (Strength Weaknesses Opportunity Threats)
  analysis
• Objectives and key challenges
• Management team/organizational chart
• Key investment highlights
• Strategic position in the industry
• Industry size/growth rates
• Market drivers
• Major industry trends(spending, commissions,
  etc.)
• Consolidation
• Segmentation/target markets
• Cyclicality
• Regulatory environment

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Due Diligence Process (contd)At the Corporate
Level

• Products/Services
• - Description of each major
  product/service category
• - Market size by category
• - Sales and margins by product/service
  category
• Customers
• - Breakdown of total customers/subscribers(
  business vs. consumer, small vs. large, etc.)
• - Historical growth in customer/subscribers
  
• Suppliers
• - List of key suppliers(number, sourcing
  policy, relationships, price volatility)
• Growth Strategy and Projections
• - Organic growth opportunities
• - Strategy for growing below-the-line
  business
• - Key areas for new development
• Acquisitions/Ventures
• - Any planned or pending acquisitions
• Legal
• Human resources
• - Retention of key employees after the IPO
• THERE MUST BE A COMPELLING STORY

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Due Diligence Process (contd)At the Business
Unit Level

• Business Units
• Business Unit Strategy
• Review Major Business Units
• - Competitive strengths/points of
  differentiation/areas of weakness
• - Growth strategy
• - Employees (breakdown, hiring, turnover,
  retention plans)
• - Pricing trends/margin trends
• - Significant threats/opportunities
• Financial Reviews
• - Reconciliation of budget vs. actual
  results
• - Annual historical/pro forma financial
  data and key operating statistics
• - 3-year projected financial results
• - detailed model including income
  statement, balance sheet, cashflow
• - Sales and profitability breakdown
  between traditional and below the line sales
• - Financial objectives (revenue growth,
  operating margin, leverage statistics, etc.)
• - Major accounting issues (revenue
  recognition, receivables, write-off policies,
  reserves, etc.)
• - Exposure to exchange rates and how
  foreign currency exposure is managed
• - Internal auditing procedures
• - Tax position, current and future

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Due Diligence Process (contd)At the Business
Unit Level

• Budgeting and Forecasting
• Personnel
• - Recent and planned management changes
• - Compensation philosophy (salary vs.
  bonus, how bonuses are determined, share
  ownership, etc.)
• - Employee recruitment and retention
  strategy
• - Significant employee agreements
• Customer Review
• - Concentration last 3 yrs and projected
• - Revenue breakdown (by service, customer,
  industry, geography)
• - Recent major wins/losses and reasons
• - Customers at risk
• - Summary of contract terms for key
  customers

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Preparing the Registration Statement

• Typical contents
• Prospectus summary
• Risk Factors
• Use of Proceeds
• Capitalization
• Selected Financial Data
• MDA
• Business
• - Overview - R D - Environment
• - Industry - Manufacturing - Properties
• - Competitive strengths/ - Sales
  Marketing - Employees
• solution
• - Strategy - Competition - Legal
• - Products - Customers
• Management
• Principal Stockholders
• Related Party Transactions
• Underwriters
• Financial Statements

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Roadshow Presentation

• The companys opportunity to sell itself to
  investors
• - Domestic roadshow
• - 8 10 days (typical in U.S.)
• - Approximately 100 face-to-face meetings
• - International roadshows usually shorter
  than domestic
• Prior to meeting management investors read
  prospectus, discuss company with research
  analysts and securities salespeople
• Group and individual meetings
• Makes or Breaks the deal
• - Investors will ask everything
• - Demanding and stressful on top management
• - Distracts from running the company
• - Must have a compelling story to tell

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Roadshow Formats

• Group Presentations
• - company tells its story in detail generally
  during a meal can be lunches with hundreds of
  investors to smaller groups
• - generally conducted by two teams but sometimes
  they will combine when necessary
• One-on-One Presentations
• - expected to generate the majority of quality
  institutional demand
• - range from meetings with a single portfolio
  manager/buyside analyst to small group sessions
  with multiple portfolio managers and buyside
  analysts
• - will take place in cities throughout the
  United States and Europe
• - will be conducted by the two teams separately
  with the exception of certain key accounts where
  the teams will combine for maximum impact
• Conference Calls
• - on as-needed basis with select investors who
  cannot attend roadshow meeting
• - maybe group calls as well as one-on-one

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Pricing Overview

• Teams meet, share feedback and ascertain demand
  and pricing
• When final pricing date has been determined
  investors are told the deadline for submitting
  indications of interest and the closing of the
  book
• After closing the book the lead manager and
  co-managers assess
• - Demand
• - Price sensitivity
• - Allocation issues
• - Aftermarket behavior
• The lead manager meets the co-management and
  recommends an offering price that maximizes the
  offering proceeds to company and favorable
  aftermarket performance
• Company and the underwriter agree on offering
  price, and sign underwriting and syndicate
  agreements

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Typical Pricing Process
Pricing Process Last Days of Roadshow


Pricing Day

• Bookof Demand
• Size
• Quality
• Price Sensitivity
• Likely aftermarket demand

Trading begins
Analysis
Agreement on Price/Size
Allocations to investors at agreed initial
price
Market determines price

• External Factors
• Recent Developments
• - Stock Price levels
• - Market in general
• - Industry
• - Comparables
• - New Issues

Price Support Activity Green Shoe Option Exercised
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After the IPO

• Regulation FD Fair Disclosure
• - The SEC is adopting new rules to address
  three issues the selective disclosure by issuers
  of material non public information when insider
  trading liability arises in connection with a
  traders use or known possession of material
  non public information and when breach of a
  family or other non-business relationship may
  give rise to liability under the misappropriation
  theory of insider trading. The rules are designed
  to promote the full and fair disclosure of
  information by issuers, and to clarify and
  enhance existing prohibitions against insider
  trading.
• Regular filings with the SEC
• Earnings announcements
• Quarterly and annual financial statements
• Material corporate events
• Manage expectations
• Meet or exceed investors expectations

26
IPO Dutch Auction Innovation in IPO Pricing

• Dutch Auction is an auction method that uses a
  bidding process to find an optimal market price
  for the stock, the lowest price at which an
  issuing company can sell all the available
  shares. An alternative to the traditional
  negotiated pricing process used by underwriters
  to set IPO prices, this auction format was most
  recently employed by Google and is used for US
  Treasury auctions. Also called a descending
  price auction, it was named after the famous
  auctions of Dutch tulip bulbs in the 17th
  century. http//www.investorwords.com/1603/Dutch_a
  uction.html

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Dutch Auction Case Study Google

• The ABCs of a Unique IPO
• IPO Dutch Auctions vs. Traditional Allocation
• Case Study Google IPO Prospectus
• Lifting the Google Lid
• Another View of the Google IPO

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Conclusion

• Improved investor feedback into the pricing
  mechanism.
• Will the Dutch Auction gain wider acceptance?
• Will this reduce the short-term price increases
  that often follow the IPO?
• What are the implications for underwriters?
• What are the implications for investors?