Risk Management and Financial Institutions. Hull John C.
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is 2.7182818 …) The IPO method was not a pure Dutch auction because Google reserved the right to change the number of shares that would be issued and the percentage allocated to each bidder when it saw the bids.
Some investors expected the price of the shares to be as high as $120. But when Google saw the bids, it decided that the number of shares offered would be 19,605,052 at a price of $85. This meant that the total value of the offering was 19, 605, 052 × 85 or $1.67 billion. Investors who had bid $85 or above obtained 74.2 % of the shares they had bid for. The date of the IPO was August 19, 2004. Most companies would have given investors who bid $85 or more 100 % of the amount they bid for and raised $2.25 billion, instead of $1.67 billion. Perhaps Google (stock symbol: GOOG) correctly anticipated it would have no difficulty in selling further shares at a higher price later.
The initial market capitalization was $23.1 billion with over 90 % of the shares being held by employees. These employees included the founders, Sergei Brin and Larry Page, and the CEO, Eric Schmidt. On the first day of trading, the shares closed at $100.34, 18 % above the offer price and there was a further 7 % increase on the second day. Google's issue therefore proved to be underpriced – but not as underpriced as some other IPOs of technology stocks where traditional IPO methods were used.
The cost of Google's IPO (fees paid to investment banks, etc.) was 2.8 % of the amount raised. This compares with an average of about 4 % for a regular IPO.
There were some mistakes made and Google was lucky that these did not prevent the IPO from going ahead as planned. Sergei Brin and Larry Page gave an interview to Playboy magazine in April 2004. The interview appeared in the September issue. This violated SEC requirements that there be a “quiet period” with no promoting of the company's stock in the period leading up to an IPO. To avoid SEC sanctions, Google had to include the Playboy interview (together with some factual corrections) in its SEC filings. Google also forgot to register 23.2 million shares and 5.6 million stock options.
Google's stock price rose rapidly in the period after the IPO. Approximately one year later (in September 2005) it was able to raise a further $4.18 billion by issuing an additional 14,159,265 shares at $295. (Why the odd number? The mathematical constant π is 3.14159265 …)
Valuation, strategy, and tactics are key aspects of the advisory services offered by an investment bank. For example, in advising Company A on a potential takeover of Company B, it is necessary for the investment bank to value Company B and help Company A assess possible synergies between the operations of the two companies. It must also consider whether it is better to offer Company B's shareholders cash or a share-for-share exchange (i.e., a certain number of shares in Company A in exchange for each share of Company B). What should the initial offer be? What does it expect the final offer that will close the deal to be? It must assess the best way to approach the senior managers of Company B and consider what the motivations of the managers will be. Will the takeover be a hostile one (opposed by the management of Company B) or friendly one (supported by the management of Company B)? In some instances there will be antitrust issues and approval from some branch of government may be required.
BUSINESS SNAPSHOT 2.2
PeopleSoft's Poison Pill
In 2003, the management of PeopleSoft, Inc., a company that provided human resource management systems, was concerned about a takeover by Oracle, a company specializing in database management systems. It took the unusual step of guaranteeing to its customers that, if it were acquired within two years and product support was reduced within four years, its customers would receive a refund of between two and five times the fees paid for their software licenses. The hypothetical cost to Oracle was estimated at $1.5 billion. The guarantee was opposed by PeopleSoft's shareholders. (It appears to be not in their interests.) PeopleSoft discontinued the guarantee in April 2004.
Oracle did succeed in acquiring PeopleSoft in December 2004. Although some jobs at PeopleSoft were eliminated, Oracle maintained at least 90 % of PeopleSoft's product development and support staff.
2.5 SECURITIES TRADING
Banks often get involved in securities trading, providing brokerage services, and making a market in individual securities. In doing so, they compete with smaller securities firms that do not offer other banking services. As mentioned earlier, the Dodd–Frank act in the United States does not allow banks to engage in proprietary trading. In some other countries, proprietary trading is allowed, but it usually has to be organized so that losses do not affect depositors.
Most large investment and commercial banks have extensive trading activities. Apart from proprietary trading (which may or may not be allowed), banks trade to provide services to their clients. (For example, a bank might enter into a derivatives transaction with a corporate client to help it reduce its foreign exchange risk.) They also trade (typically with other financial institutions) to hedge their risks.
A broker assists in the trading of securities by taking orders from clients and arranging for them to be carried out on an exchange. Some brokers operate nationally, and some serve only a particular region. Some, known as full-service brokers, offer investment research and advice. Others, known as discount brokers, charge lower commissions, but provide no advice. Some offer online services, and some, such as E*Trade, provide a platform for customers to trade without a broker.
A market maker facilitates trading by always being prepared to quote a bid (the price at which it is prepared to buy) and an offer (the price at which it is prepared to sell). When providing a quote, it does not know whether the person requesting the quote wants to buy or sell. The market maker makes a profit from the spread between the bid and the offer, but takes the risk that it will be left with an unacceptably high exposure.
Many exchanges on which stocks, options, and futures trade use market makers. Typically, an exchange will specify a maximum level for the size of a market maker's bid-offer spread (the difference between the offer and the bid). Banks have in the past been market makers for instruments such as forward contracts, swaps, and options trading in the over-the-counter (OTC) market. (See Chapter 5 for a discussion of these instruments and the over-the-counter market.) The trading and market making of these types of instruments is now increasingly being carried out on electronic platforms that are known as swap execution facilities (SEFs) in the United States and organized trading facilities (OTFs) in Europe. (See Sections 5.1, 16.4, and 18.3.)
2.6 POTENTIAL CONFLICTS OF INTEREST IN BANKING
There are many potential conflicts of interest between commercial banking, securities services, and investment banking when they are all conducted under the same corporate umbrella. For example:
1. When asked for advice by an investor, a bank might be tempted to recommend securities that the investment banking part of its organization is trying to sell. When it has a fiduciary account (i.e., a customer account where the bank can choose trades for the customer), the bank can “stuff” difficult-to-sell securities into the account.
2. A bank, when it lends money to a company, often obtains confidential information about the company. It might be tempted to pass that information to the mergers and acquisitions arm of the investment bank to help it provide advice to one of its clients on potential takeover opportunities.
3. The research end of the securities business might be tempted to recommend a company's share as a “buy” in order to please the company's management and obtain investment banking business.
4. Suppose a commercial bank no longer wants a loan it has made to a company on its books because the confidential information it has obtained from the company leads it to believe that there is an increased chance of bankruptcy. It might be tempted to ask the investment bank to arrange a bond issue for the company, with the proceeds being used to pay off the loan. This would have the effect of replacing its loan with a loan made by investors who were less well-informed.
As a result of these types of conflicts of interest, some countries have in the past attempted to separate commercial banking from investment banking. The Glass-Steagall Act of 1933 in the United States limited the ability of commercial banks and investment banks to engage in each other's activities. Commercial banks were allowed to continue underwriting Treasury