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General Cash Offers by Public Companies

After the initial public offering a successful firm will continue to grow and from time to time it will need to raise more money by issuing stock or bonds. An issue of additional stock by a company whose stock already is publicly traded is called a seasoned offering. Any issue of securities needs to be formally approved by the firm`s board of directors. If a stock issue requires an increase in the company`s authorized capital, it also needs the consent of the stockholders.

Public companies can issue securities either by making a general cash offer to investors at large or by making a rights issue, which is limited to existing shareholders. In the latter case, the company offers the shareholders the opportunity, or right, to buy more shares at an ¬attractive ­ price. For example, if the current stock price is $100, the company might offer investors an additional share at $50 for each share they hold. Suppose that before the issue an investor has one share worth $100 and $50 in the bank. If the investor takes up the offer of a new share, that $50 of cash is transferred from the investor`s bank account to the company`s. The investor now has two shares that are a claim on the original assets worth $100 and on the $50 cash that the company has raised. So the two shares are worth a total of $150, or $75 each.

Rights Issues

Easy Writer Word Processing Company has 1 million shares outstanding, selling at $20 a share. To finance the development of a new software package, it plans a rights issue, allowing one new share to be purchased for each 10 shares currently held. The purchase price will be $10 a share. How many shares will be issued? How much money will be raised? What will be the stock price after the rights issue?

The firm will issue one new share for every 10 old ones, or 100,000 shares. So shares outstanding will rise to 1.1 million. The firm will raise $10 ГЧ 100,000 = $1 million. Therefore, the total value of the firm will increase from $20 million to $21 million, and the stock price will fall to $21 million/1.1 million shares = $19.09 per share.

In some countries the rights issue is the most common or only method for issuing stock, but in the United States rights issues are now very rare. We therefore will concentrate on the mechanics of the general cash offer.

GENERAL CASH OFFERS AND SHELF REGISTRATION

When a public company makes a general cash offer of debt or equity, it essentially follows the same procedure used when it first went public. This means that it must first register the issue with the SEC and draw up a prospectus.8 Before settling on the issue price, the underwriters will usually contact potential investors and build up a book of likely orders. The company will then sell the issue to the underwriters, and they in turn will offer the securities to the public.

Companies do not need to prepare a separate registration statement every time they issue new securities. Instead, they are allowed to file a single registration statement covering financing plans for up to 2 years into the future. The actual issues can then be sold to the public with scant additional paperwork, whenever the firm needs cash or thinks it can issue securities at an attractive price. This is called shelf registration ¤the registration is put ¬on the shelf, ­ to be taken down, dusted off, and used as needed.

Think of how you might use shelf registration when you are a financial manager. Suppose that your company is likely to need up to $200 million of new long-term debt over the next year or so. It can file a registration statement for that amount. It now has approval to issue up to $200 million of debt, but it isn`t obliged to issue any. Nor is it required to work through any particular underwriters ¤the registration statement may name the underwriters the firm thinks it may work with, but others can be substituted later.

Now you can sit back and issue debt as needed, in bits and pieces if you like. Suppose Merrill Lynch comes across an insurance company with $10 million ready to invest in corporate bonds, priced to yield, say, 7.3 percent. If you think that`s a good deal, you say ¬OK ­ and the deal is done, subject to only a little additional paperwork. Merrill Lynch then resells the bonds to the insurance company, hoping for a higher price than it paid for them.

Here is another possible deal. Suppose you think you see a window of opportunity in which interest rates are ¬temporarily low. ­ You invite bids for $100 million of bonds. Some bids may come from large investment bankers acting alone, others from adhoc syndicates. But that`s not your problem; if the price is right, you just take the best deal offered.

Thus shelf registration gives firms several different things that they did not have previously:

1. Securities can be issued in dribs and drabs without incurring excessive costs.

2. Securities can be issued on short notice.

3. Security issues can be timed to take advantage of ¬market conditions ­ (although any financial manager who can reliably identify favorable market conditions could make a lot more money by quitting and becoming a bond or stock trader instead).

4. The issuing firm can make sure that underwriters compete for its business. Not all companies eligible for shelf registration actually use it for all their public issues. Sometimes they believe they can get a better deal by making one large issue through traditional channels, especially when the security to be issued has some unusual feature or when the firm believes it needs the investment banker`s counsel or stamp of approval on the issue. Thus shelf registration is less often used for issues of common stock than for garden-variety corporate bonds.

SHELF REGISTRATION A procedure that allows firms to file one registration statement for several issues of the same security.

GENERAL CASH OFFER Sale of securities open to all investors by an already public company.

SEASONED OFFERING Sale of securities by a firm that is already publicly traded.

RIGHTS ISSUE Issue of securities offered only to current stockholders.