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VIII Sourcing Equity Globally

Read Chapter 12. pp. 411-426

1. Designing a strategy to source equity globally

2. Foreign equity listing and issuance

3. Effect of cross-listing and equity issuance on

share price4. Barriers to cross-listing and selling equity

abroad

5. Alternative instruments to source equity inglobal markets

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Overview

Financing in global capital markets lower a firms cost of

capital by improving the liquidity of its shares and byovercoming market segmentation.

To access global capital markets, a firm must design a

strategy to attract international investors, which requires

identifying and choosing alternative paths to accessglobal markets

improving the quality and level of its disclosure

making its accounting and reporting standards more

transparent to potential foreign investors.

We focus on firms in emerging markets and smaller

industrial country markets, i.e., less liquid or segmented

markets.

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1. Designing a Strategy to Source Equity Globally

Designing a capital sourcing strategy requires that

management agree upon a long-run financialobjective and then choose among the various

alternative paths to get there.

An investment bank often acts as an official advisorto the firm.

Investment bankers are in touch with potential

foreign investors and know what they currently

require, and can also help navigate the numerousinstitutional and regulatory barriers in place.

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1. Strategy: alternative path

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. Firms should start with an international bond

offering in less liquid markets and move on to

more liquid markets, and/or cross-listing equity

shares on more highly liquid foreign markets.

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Exhibit 12.1 Alternative Paths

Domestic Financial Market Operations

Euroequity IssueGlobal Markets

International Bond IssueLess Liquid Markets

International Bond IssueTarget Market or Eurobond Market

Equity ListingsLess Liquid Markets

Equity IssueLess Liquid Markets

Equity Listing and IssueTarget Market

Source: Oxelheim, Stonehill, Randy, Vikkula, Dullum, and Modn, Corporate Strategies to Internationalise the Cost of Capital,Copenhagen: Copenhagen Business School Press, 1998, p. 119.

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1. Strategy: depositary receipts

Depositary receipts(depositary shares) are negotiable

certificates issued by a bank to represent the underlyingshares of stock, which are held in trust at a foreign

custodian bank.

Global depositary receipts (GDRs) are certificates traded

outside the US. American depositary 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 ADRrepresenting 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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American Depositary Receipts

issued by a bank representingunderlying shares held

by a custodial bank

Publicly traded firm

outside the U.S.

Receipts for shares

listed on U.S. exchange

Shares traded on local

stock exchange

Shares

Shares

Receipts(ADRs)

Arbitrage

Activity

Traded by

U.S. investors

Exhibit 12.2 Mechanics of American DepositaryReceipts

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1. Strategy

Investors can exchange ADRs for the underlying

foreign shares, so arbitrage keeps foreign and USprices of any given share the same after adjusting

for transfer costs.

ADRs also convey certain technical advantages to

US shareholders (tax, currency, and trading, etc).

While ADRs are quoted only in US dollars and

traded only in the US, Global Registered Shares

(GRSs) can be traded on equity exchanges aroundthe globe in a variety of currencies.

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1. Strategy

Global Registered Shares are nearly identical to

the structure used for Canada-US cross-listedstocks. All cross-listed Canadian stocks trade as

ordinary shares, not as ADRs.

Investors can trade GRSs in several exchanges,which are electronically linked.

The NYSE dealing fee for ADRs cost 3-5 cents

per share, and for GRS a flat cost of $5. This flat

trading cost of GRS would appeal to the largeinstitutional investors.

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2. 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 asegmented 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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Exhibit 12.5 Size and trading volume of exchanges

# domestic # foreign volume (U$b)

NYSE 1894 472 10,311NASDAQ 3268 381 7,254

LSE 1892 382 4,001

Euronext 1114 na 1,988

Tokyo 2119 34 1,564

Deutsche 715 219 1,212

Spain 986 29 653

Italy 288 7 634Swiss 258 140 600

Taiwan 638 3 634

Korea 679 0 597

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2. Listing and Issuance: NYSE vs LSE

NYSE is more liquid, more superior in fairness,

and in crisis management than LSE.

LSE spreads are comparable to NASDAQ spread.

LSE offers advantages of being less onerous in

disclosure requirements and lower listing cost,resulting in a large of foreign firms listing their

shares on LSE.

NYSE operates as auction market, while LSE as

dealer market. Efficacy of exchange structure is

an on-going issue.

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3. Effect of cross-listing and equity issuance onshare price

Cross-listing may have a favorable impact on share

price if the new market values the firm or its industrymore than the home market does (i.e., segmentedmarkets)

In segmented markets, firms can benefit from cross-

listing by increasing investor recognition andparticipation in the primary and secondary markets.

It is well known that the combined impact of a newequity issue undertaken simultaneously with a cross-

listing has a more favorable impact on stock price thancross-listing alone.

Even US firms can benefit by issuing equity abroad, asthe foreign listing would increase investor recognition

and participation in the primary and secondary markets.

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4. 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. One view is that the worldwide trend toward requiring

fuller, more transparent, and more standardized

financial disclosure may have the desirable effect of

lowering the cost of equity capital.

The other view is that the US level of required

disclosure is onerous and costly burden to the firms.

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5. Alternative Instruments to SourceEquity 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 inmore 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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5. Alternative Instruments

A directed publ ic share issueis defined as one that istargeted at investors in a single country andunderwritten in whole or in part by investmentinstitutions from that country.

A directed share issue often are motivated by a need tofund acquisitions or major capital investments in a

target foreign market.

The gradual integration of the worlds capital markets

and increased international portfolio investment has

spawned the emergence of a very viable Euroequity

market.

The Euro market is a generic term for international

securities issues originating and being sold anywhere in

the world.

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5. Alternative Instruments

A firm can now issue equity underwritten and

distributed in multiple foreign equity markets,sometimes simultaneously with distribution in the

domestic market.

The largest issues in Euroequity markethave been

in conjunction with a wave of privatizations ofgovernment-owned assets. Examples are British

Telecom in 1984, British Steel in 1988, Deutsche

Telecom (U$13.3b in 1996), Telefonos de Mexico

(U$2b in 1991).

It appears that many privatized firms has improved

their performance following their privatizations.

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5. Instruments

One type of directed issue with a long history as a source

of both equity and debt is the private placementmarket.

A private placement is the sale of a security to a small set

of qualified institutional buyers (QIB) under SEC Rule

144A. The rule also allows the QIBs to trade the

securities on a screen-based automated trading system

called PORTAL.

There are about 4,000 QIBs, maily investment bankers,

investment, insurance companies, pension funds and

charitable institutions.

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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5. Instruments

Private equity fundsare usually limited partnerships of

institutional and wealthy individual investors that raisetheir 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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5. Instruments

Strategic alliancesare normally formed by firms

that expect to gain synergies from one or more ofthe following joint efforts:

Sharing the cost of developing technology

Gaining economies of scale or scopeFinancial assistance (lowering of cost of capital

through attractively priced debt or equity

financing)

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Mini-Case: Deutsche Banks Global Registered Shares

Do you believe the differences between ADRs

and GRSs are real or cosmetic? Why?

Why do you think Deutsche Bank would proceed

with a GRS listing when so many others have

not? What do you think Deutsche Bank concluded

from DaimlerChryslers experience with GRSs?