S&S Air goes public Case study
- a) What are the differences in expenses to S&S Air if it uses a Dutch action IPO versus a traditional IPO?
A private company can sell its shares through the initial public offering to become a public company using the traditional IPO pricing method or the Dutch Action pricing method. The conventional method entails the offering company to hire underwriters, who usually are investment banks, to oversee the sale of the company’s securities. In the traditional IPO process, investment banks often determine securities prices by assessing the demand for such shares. The underwriters then conclude on the share price ranges after contacting different funding banks and other leading investors while on roadshows.
Through the Dutch auction method, the offering company’s underwriter will post auctions of the share prices. The price in the Dutch auction declines until the offering company’s target is met. Therefore, investors will place their bids by stating the price and amount of shares they are willing to purchase. The difference between the Dutch auction IPO and the traditional IPO is that the Dutch auction allows many buyers to participate in the auction process. The share price is determined by forces of ‘demand and supply’ (Chen, 2019). Hence, the traditional IPO process expenses are significantly higher than those of a Dutch Auction IPO. S&S Air will incur significant marketing expenses if they use the traditional IPO compared to the Dutch Auction IPO method since the underwriters have to promote S&S shares on roadshows.
Furthermore, underwriting expenses are relatively lower when using the Dutch Auction IPO method since the auction process determines the prices. Underwriting fees are higher when using the traditional IPO method because underwriters have to set prices for shares being offered. Also, S&S Air will significantly reduce the likelihood of underpricing costs when using a Dutch Auction pricing method.
- b) Should the company go public through a Dutch action or use a traditional underwritten offering?
S&S Air should go public through a Dutch Auction as the IP’s value will belong to Mark and Todd’s rather than investment intermediaries (Hensel, 2005). A Dutch Auction IPO minimizes the risk of ‘leaving money on the table’ as the share price is closer to the market value.
- a) How can we calculate the optimal size of the IPO?The optimal size of the IPO is determined through factors like the demand for the company’s stock and the funding that the issuing company wants to achieve. Therefore, to calculate the optimal size of the IPO, S&S Air should calculate each share’s value by dividing the company’s value by the number of shares it is offering (Sekirin, 2017). The company should then determine the offering price per share relative to the value per share by incorporating factors such as the demand of the shares and the funding requirements of the company.
- b) What are the advantages and disadvantages of increasing the size of the IPO to 90 million?
The advantage of increasing the size of the IPO is that if the IPO is successful and the entire stock is sold, the company will have generated a lot of capital to help expand the business (Fedorov, 2020). Also, the company will not incur further expenses when generating funds through a secondary offering. However, if the size of the IPO is increased to 90 million, it might be difficult for the company to create enough investor demand for the stock. In this case, the IPO will be deemed unsuccessful as most of the stock won’t be issued; hence S&S Air won’t raise enough capital. If the IPO is unsuccessful, the company will incur further expenses when trying to raise additional funds through a secondary offering.
- 3.Many employees of S&S Air have shares of stock in the company because of an existing employee stock purchase plan. To sell the stock, the employees can tender their shares to be sold in the IPO at the offering price, or the employees can retain their stock and sell it in the secondary market after S&S Air goes public. What are the advantages and disadvantages of each option? Todd asks you to advise the employees about which option is best. What would you advise the employees?
Employees tendering shares to be sold in the IPO at the offering price has its advantages. First, this option raises capital for both the company and the employees. The employees can thus generate additional income even before the company goes public. Secondly, tendering has a predetermined fixed price, assuring the employees that there is an amount they will receive regardless of how the share prices will behave in the market. A disadvantage of tendering shares to be sold in the IPO is that the employees have to wait for a specified amount of time before selling their shares. There is usually a lock-up period of 180 days that prevent employees from selling their stock right away. Besides, the company’s offer price may be underpriced, and thus the employees might receive a relatively lower amount than the actual market share value.
Retaining stock and selling it once S&S Air goes public has advantages and disadvantages as well. An advantage of stock of sale through the secondary market includes, the employees can generate income for their shares immediately and more conveniently as there is no lock-up period as in the IPO process. Secondly, the issuing company does not set the stock price as the forces of demand and supply in the stock market determine the stock prices. However, due to a large number of investors in the secondary markets, the prices of securities have high volatilities, resulting in sudden losses for the employee. Furthermore, there is a high risk in secondary markets due to various external factors. Hence, the valuation of the stock in the market can significantly be altered within a short period.
Therefore, I would advise the S&S employees to tender their shares to be sold at the IPO offering price because the risk associated with this option is minimal.
- 5 years after IPO, S&S Air is planning to raise fresh equity capital by selling a large new issue of common stock. S&S Air is currently a publicly traded corporation, and it is trying to choose between an underwritten cash offer and a rights offering (not underwritten) to current shareholders. S&S Air management is interested in minimizing the selling costs and has asked you for advice on the choice of issue methods. What is your recommendation and why?
S&S Air should choose the rights offering option as its expenses are relatively lower than the underwritten cash offering because no underwriting is involved. Furthermore, this option will protect the shareholders from underpricing, which will ensure maximum earnings.