Chapter 15

Sourcing Equity Globally

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Sourcing Equity Globally

To implement the goal of gaining access to global capital markets a firm must begin by designing a strategy that will ultimately attract international investors. This would mean identifying and choosing alternative paths to access global markets. This would also require some restructuring of the firm, improving the quality and level of its disclosure, and making its accounting and reporting standards more transparent to potential foreign investors.

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Designing a Strategy to Source Equity Globally

Designing a capital sourcing strategy requires that management agree upon a long-run financial objective and then choose among the various alternative paths to get there. Often, this decision making process is aided by an early appointment of an investment bank as an official advisor to the firm. Investment bankers are in touch with potential foreign investors and know what they currently require, and can also help navigate the numerous institutional and regulatory barriers in place.

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Designing a Strategy to Source Equity Globally

Most firms raise their initial capital in their own domestic market. However, most firms that have only raised capital in their domestic market are not well known enough to attract foreign investors. Incremental steps to bridge this gap include conducting an international bond offering and/or cross-listing equity shares on more highly liquid foreign stock exchanges.

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Exhibit 15.1 Alternative Paths to Globalize the Cost and Availability of Capital

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Designing a Strategy to Source Equity Globally

Depositary receipts (depositary shares) are negotiable certificates issued by a bank to represent the underlying shares of stock, which are held in trust at a foreign custodian bank. American depository receipts (ADRs) are certificates traded in the United States and denominated in US dollars. ADRs are sold, registered, and transferred in the US in the same manner as any share of stock with each ADR representing some multiple of the underlying foreign share (allowing for ADR pricing to resemble conventional US share pricing between $20 and $50 per share).

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Exhibit 15.2 Mechanics of American Depositary Receipts (ADRs)

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Designing a Strategy to Source Equity Globally

ADRs can be exchanged for the underlying foreign shares, or vice versa, so arbitrage keeps foreign and US prices of any given share the same after adjusting for transfer costs. ADRs also convey certain technical advantages to US shareholders. While ADRs are quoted only in US dollars and traded only in the US, Global Registered Shares (GRSs) can be traded on equity exchanges around the globe in a variety of currencies.
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Exhibit 15.3 Characteristics of Depositary Receipt Programs

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Foreign Equity Listing and Issuance

A firm must choose one or more stock markets on which to cross-list its shares and sell new equity. Just where to go depends mainly on the firms specific motives and the willingness of the host stock market to accept the firm.

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Foreign Equity Listing and Issuance

Cross-listing attempts to accomplish one or more of many objectives: Improve the liquidity of its existing shares and support a liquid secondary market for new equity issues in foreign markets Increase its share price by overcoming mis-pricing in a segmented and illiquid home capital market Increase the firms visibility Establish a secondary market for shares used to acquire other firms Create a secondary market for shares that can be used to compensate local management and employees in foreign subsidiaries

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Effect of Cross-Listing and Equity Issuance on Share Price

Cross-listing may have a favorable impact on share price if the new market values the firm or its industry more than the home market does. It is well known that the combined impact of a new equity issue undertaken simultaneously with a cross-listing has a more favorable impact on stock price than cross-listing alone. Even US firms can benefit by issuing equity abroad as increased investor recognition and participation in the primary and secondary markets results.

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Barriers to Cross-Listing and Selling Equity Abroad

There are certainly barriers to cross-listing and/or selling equity abroad. The most serious of these includes the future commitment to providing full and transparent disclosure of operating results and balance sheets as well as a continuous program of investor relations. The US school of thought is that the worldwide trend toward requiring fuller, more transparent, and more standardized financial disclosure of operating results and balance sheet positions may have the desirable effect of lowering the cost of equity capital.

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Alternative Instruments to Source Equity in Global Markets

Alternative instruments to source equity in global markets include the following:
Sale of a directed public share issue to investors in a target market Sale of a Euroequity public issue to investors in more than one market (foreign and domestic markets) Private placements under SEC Rule 144A Sale of shares to private equity funds Sale of shares to a foreign firm as part of a strategic alliance
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Alternative Instruments to Source Equity in Global Markets

A directed public share issue is defined as one that is targeted at investors in a single country and underwritten in whole or in part by investment institutions from that country. The issue might or might not be denominated in the currency of the target market. The shares might or might not be cross-listed on a stock exchange in the target market.

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Alternative Instruments to Source Equity in Global Markets

The gradual integration of the worlds capital markets and increased international portfolio investment has spawned the emergence of a very viable Euroequity market. A firm can now issue equity underwritten and distributed in multiple foreign equity markets, sometimes simultaneously with distribution in the domestic market. The Euro market (a generic term for international securities issues originating and being sold anywhere in the world), was created by the same financial institutions that had previously created an infrastructure for the Euronote and Eurobond markets.

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Alternative Instruments to Source Equity in Global Markets

One type of directed issue with a long history as a source of both equity and debt is the private placement market. A private placement is the sale of a security to a small set of qualified institutional buyers under SEC Rule 144A.

Since the securities are not registered for sale to the public, investors have typically followed a buy and hold policy.
Private placement markets now exist in most countries.

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Alternative Instruments to Source Equity in Global Markets

Private equity funds are usually limited partnerships of institutional and wealthy individual investors that raise their capital in the most liquid capital markets. These investors then invest the private equity fund in mature, family-owned firms located in emerging markets. The investment objective is to help these firms to restructure and modernize in order to face increasing competition and the growth of new technologies. Private equity funds differ from traditional venture capital funds as private equity funds operate in many countries, fund companies in many industry sectors and have often have a longer time horizon for exiting.

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Alternative Instruments to Source Equity in Global Markets

Strategic alliances are normally formed by firms that expect to gain synergies from one or more of the following joint efforts: Sharing the cost of developing technology Gaining economies of scale or scope Financial assistance (lowering of cost of capital through attractively priced debt or equity financing)

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Mini-Case Questions: Petrobrs

Why do you think Petrobrs cost of capital is so high? Are there better ways, or other ways, of calculating its weighted average cost of capital? Does this method of using the sovereign spread also compensate for currency risk?

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Mini-Case Questions: Petrobrs

The final quote that ones view on the direction of the broad Brazilian market suggests that potential investors consider the relative attractiveness of Brazil in their investment decision. How does this perception show up in the calculation of the companys cost of capital? Is the cost of capital really a relevant factor in the competitiveness and strategy of a company like Petrobrs? Does the corporate cost of capital really affect competitiveness?

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Chapter 15

Additional Chapter Exhibits

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Exhibit 1 Petrobrs Suffers an Uncompetitive Cost of Capital

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Exhibit 2 The Brazilian Sovereign Spread (December 1997August 2005)

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