Raising Capital in Turbulent Times

1. Raising Capital in Turbulent Times Craig Dunbar Associate Professor Paul Desmarais / London Life Finance Fellow

2. My goals • Address some basic questions: • What is business (finance) research? • Is research important for a school like Ivey? • Provide a glimpse into some of my research • Questions addressed • Methods used

3. “Factoids” about research • Research is important for any business school to pursue • Research can be very costly • Finance databases cost Ivey in well in excess of $100,000 each year • Research is a time consuming activity

4. Research importance • Contributes to the practice of management • Addresses issues of relevance for policymakers • Important to faculty recruitment and retention • Research culture can have a positive impact on teaching • Direct impact on school ratings

5. Financial Times Ranking of Business Schools • Ivey’s overall rank is 19 • 25% of ranking is based on research output in top publications (adjusted for faculty size) Ivey’s research score is 37 (maximum = 100) Other schools: 1. Wharton (University of Pennsylvania) = 91 35. York = 13 37. McGill = 20 46. Rotman (Toronto) = 24

6. Potential roles for alumni • Contribution of funds • Source of ideas / data • Provide constructive feedback

7. The research process in finance • The research cycle • Uncover empirical “regularities” or “facts” • Theory building • Develop models (usually mathematical) based on assumptions about human behaviour to explain the “facts” • Further empirical investigation • Test predictions from theories, uncover new facts • Source of data • Interviews / surveys (less common in finance) • Market data (U.S. bias)

8. Stock market capitalization (1999) Source: RIMES Data Services

9. My research: a focus on capital raising Initial public offerings (IPOs) • Company decides to “go public”, selects an investment bank to “underwrite” the offering • Next 2-3 months: • Investment bank generates initial “prospectus” • submits for review and approval by the SEC, OSC • Next 4-6 weeks: • Investment bank conducts “road show” and lines up buyers for the stock in the IPO (“building the book”) • Finally: • Offering is approved, final terms are set and selling begins

10. IPOs in 2000: an exceptional year • ~$50 billion raised in 326 IPOs • Record for capital raised: • ~$55 billion on 437 IPOs in 1999 (next highest year <$40 B) • Record number of IPOs • 648 in 1996 • Number of canceled IPOs in 2000: 261 (45% of total filed) • “Typical” fraction canceled in any year ~ 10-20% • 2001 – even worse than 2000 !

11. September 24, 2001 IPOs Unlikely to See DaylightIn Continuing Weak Market By RAYMOND HENNESSEYDow Jones Newswires During the nearly weeklong hiatus in stock trading brought on by the terrorist attacks on Sept. 11, some Wall Street underwriters figured that initial public offerings of stock could be priced within a week or two of the market reopening. That was because stocks, after an initial drop, were expected to stabilize within a few days of trading.That hasn't happened. Instead, stocks dropped consistently all last week, and IPOs are off the table until there are signs that the selling has ended. "Our best-case scenario was that we'd get a drop, get a repriced market, down to some level where investors felt comfortable, and then hit the phones and start up selected IPOs as soon as we could," said Mark Connelly, head of U.S. equity capital markets at UBS AG's UBS Warburg, which had been expected to lead most of the IPOs in September. "We didn't get that." Now, underwriters, like most on Wall Street, have to sit back and wait to "find some kind of stable trading range that feels pretty steady," Mr. Connelly said. It is likely now that there won't be an IPO this month, though the IPO market isn't closed for the rest of the year. Many offerings slated for September have been pushed into October, and deals that had been pegged for the fourth quarter are, for the most part, still on schedule. Despite the growing negative sentiment for new issues, there have been some factors working in the IPO market's favor. The first is that there has been some limited stock-issuance by already public companies, through secondary and follow-on offerings. On Thursday, lending firm Allied Capital Corp., of Washington, sold three million shares in a follow-on offering led by Merrill Lynch & Co. As a sign of solidarity, Merrill added two firms hard hit by the World Trade Center's collapse -- Keefe, Bruyette & Woods Inc. and Sandler, O'Neill & Partners LP -- as underwriters on the deal, with each of the two firms selling 50,000 shares. Also, Annaly Mortgage Inc., a real-estate investment trust in New York, sold 14 million shares through Warburg. Though none of the above offerings is an IPO, traditionally IPOs feed off the secondary and follow-on markets. If existing stocks can price offerings, the thinking is, then it normally isn't long before IPOs can price.

12. The genesis of a research idea • Wilt Chamberlain’s restaurant IPO in 1992 • tremendous apparent investor interest during road shows • in the end, investors backed away and the IPO was canceled • How risky are IPOs? • What are the consequences of failure?

13. Research chronology • The choice between firm-commitment and best-efforts offering methods in IPOs: The effect of unsuccessful offers • Journal of Financial Intermediation, 1998 • Factors affecting investment bank initial public offering market share • Journal of Financial Economics, 2000 • Offer term adjustments in IPOs; Second time lucky: the performance of withdrawn IPOs that return to the market • Work in progress (with Steve Foerster, Tom Bates)

14. How risky are IPOs? • My 1998 study considered all attempted IPOs between 1979 and 1993 (from Thomson Financial Securities Data) • Fraction of canceled IPOs: • 18% on average • Minimum of 8% (1989), maximum of 39% (1982) • Uncertainty about proceeds raised: • How to measure uncertainty? • % change in proceeds = • (actual proceeds – expected proceeds) / (expected proceeds) • average absolute % change in proceeds = 35%

15. Which IPOs are more likely to be canceled? • IPOs by: • Younger firms • Firms with lower profits / revenues leading up to the offering • Firms attempting to raise less capital • Firms “underwritten” by “less reputable” investment banks

16. How costly are failed IPOs to issuers? • 1998 study of all attempted IPOs between 1979 and 1993 • Of issuers that cancel IPOs, only 6% (39 of 647) ever go public • Of IPOs canceled in 1999 and 2000, only 3 have returned for a successful IPO • Average time from withdrawal to successful IPO is over 2 years

17. How costly are canceled IPOs for investment banks? • Part of larger study published in 2000 examining factors affecting investment bank market share in the IPO market • I examine yearly changes to market share by investment bank over the period from 1984 to 1995 • I relate changes in market share to: • performance of past IPOs (short and long term) • fees charged by the bank • change in reputation of the bank’s analysts • industry specialization of the bank • past IPO cancellations

18. How costly are canceled IPOs for investment banks? • Withdrawals have a negative effect on investment bank market share • a 10% increase in withdrawals results in a 0.5% reduction in market share (mean annual market share from 1984 to 1995 is 3.7%) • a more significant relation in declining volume IPO markets • 80% of banks only associated with withdrawals in one year get no business in the next year

19. …Even in declining markets • DLJ (now part of CS First Boston) market share dropped from 3.1% in 1987 to 1.9% in 1988. Their only withdrawal was on October 17, 1987 • Goldman Sachs market share dropped from 19.8% in 1990 to 13% in 1991. Their only withdrawals were during the significantly declining market from August to October 1990.

20. Cutting price is a good alternative • Part of ongoing research study examining short and long-run performance of IPOs broken down by the price adjustments made at the time of the IPO • Alternative to canceling an IPO: cutting the IPO price • Long-run performance of issuers that cut offering price and size is as good as other issuers.

21. How do we measure long-run performance? • Compare IPO firm return to some benchmark • What’s a reasonable benchmark? • S&P 500 • Firms (portfolios) with similar “beta” • Firms (portfolios) with similar size (market capitalization) and market-to-book ratio • “Abnormal” return = • return on IPO firm – return on benchmark • Is abnormal return significantly different from zero? • Abnormal returns are not normally distributed • Bootstrapping!

22. What happens to firms that cancel an IPO? • Problem: hard to get reliable data on private firms • Some “facts” for US IPOs that withdrew an IPO from 1987 to 2000 (from ongoing research project) • 14% of these firms obtained venture capital financing prior to attempting the IPO (for successful IPOs,42% had venture capital backing) • 7% obtain venture capital financing after withdrawal • 21% of firms withdrawing are subsequently acquired • 12% return for a successful IPO • No information on 65% of firms

23. What happens to firms that cancel an IPO? • Some facts about firms that return for a successful IPO • 60% had venture capital funding prior to withdrawal • 38% obtain venture capital funding after withdrawal • 75% change the investment bank used to lead the underwriting • Proceeds raised increased 24% if using the same bank and it takes 2 years to return, on average • Proceeds raised increased 100% if using a different bank and it takes 3 years to return, on average

24. Some unresolved questions • Under what circumstances is it best for a firm to cancel an IPO? • What can firms do to increase the chance of success? • What changes could be made to the regulation of IPOs to reduce the risks for issuers? • Should firms attempt to “time the market”?