IPOs, Cash Management, and Corporate Bonds

1. Go Public With An IPO?

Hundreds of companies annually hold initial public offerings (IPOs) to move from being pri­vate to being public. In 2014, the number of firms going public was at its fastest pace in years, as investors bid aggressively for new shares of new companies, paying on average 14.5 times annual sales for firms. The average U.S. IPO stock price in 2014 increased 19 percent, rewarding investors.8 However, nearly three quarters of the firms going public in 2014 were unprofitable, and most had annual sales of less than $50 million. In addition to Alibaba, some of the most suc­cessful IPOs in 2014 were GoPro, maker of the popular action photography camera, whose stock hit the market mid-year priced at $24 and rose to $71 for a 195 percent total return. Also in 2014, the IPO from Immune Design, a large pharmaceutical firm, saw its initial stock price of $12 rise to $34, up 184 percent. There were 275 IPOs on the U.S. stock markets in 2014, up from 222 the prior year. However, not all initial public offering stock prices increased. Even Facebook’s stock dropped dramatically after its IPO, although it eventually recovered nicely.

“Going public” means selling off a percentage of a company to others to raise capital; consequently, it dilutes the owners’ control of the firm. Going public is not recommended for companies with less than $10 million in sales because the initial costs can be too high for

the firm to generate sufficient cash flow to make going public worthwhile. One dollar in four is the average total cost paid to lawyers, accountants, and underwriters when an initial stock issuance is under $1 million; $1 in $20 will go to cover these costs for issuances over $20 mil­lion. In addition to initial costs involved with a stock offering, there are costs and obligations associated with reporting and management in a publicly held firm. For firms with more than $10 million in sales, going public can provide major advantages. It can allow the firm to raise capital to develop new products, build plants, expand, grow, and market products and services more effectively.

2. Keep Cash Offshore is Earned Offshore?

Many U.S. firms have most of the cash on their balance sheet in overseas accounts, since a large percentage of their revenues are derived in foreign countries. Many such firms prefer to leave their cash outside the United States because to use those funds to pay dividends or purchase treasury stock, for example, would trigger a big U.S. corporate income tax payment. During calendar year 2014, U.S.-based companies added $206 billion to their stockpiles of off­shore profits, recorded as “Cash” on their balance sheet. Keeping earnings (cash) in banks in low-tax countries has resulted in U.S. multinational companies having now accumulated $1.95 trillion in cash held outside the United States, up 11.8 percent from a year earlier, according to securities filings from 307 corporations reviewed by Bloomberg News. Three U.S.-based companies in particular—Microsoft, Apple, and IBM—added $37.5 billion, or 18.2 percent of the total increase in 2014. So, when you see “Cash” on a firm’s balance sheet, that cash may not be readily available, given the firm may prefer not to pay U.S. taxes on those “foreign” earnings. The federal government is currently considering legislation to tax those foreign cash accounts, such as pay a one-time tax of 10 percent and bring all that cash back to U.S. banks, but nothing has been decided so far.

3. Issue Corporate Bonds for What Purpose?

Corporations normally issue bonds to raise capital for acquisitions, to refinance debt, and to fund various strategies expected to yield long-term profits. However, increasingly, companies are issuing bonds to buy back their own stock and to pay cash dividends to shareholders. This practice has become a concern. For example, in the first half of 2015, at least ten junk­rated or B-rated companies, including Sirius XM Holdings, Nathan’s Famous (Hotdogs), and McGraw-Hill Education, issued more than $5.4 billion in bonds at least in part to finance pay­ing out cash dividends and buying back company stock. For all of 2014, 30 companies issued more than $14.8 billion of bonds for the same purpose. Companies in the S&P 500 in 2014 paid out a record $93.4 billion in dividends and repurchased $148 billion worth of stock— partly (or largely) by issuing corporate bonds. Stock buybacks in 2015 are on pace to exceed $600 billion, a huge increase. The CFO of Legg Mason says “debt analysts hate companies’ practice of using debt to fund buybacks.”9 A strategic decision facing corporations therefore, is whether to issue bonds to raise capital to pacify shareholders with cash dividends and purchase company stock, or to issue bonds to finance strategies carefully formulated to yield greater revenues and profits.

Source: David Fred, David Forest (2016), Strategic Management: A Competitive Advantage Approach, Concepts and Cases, Pearson (16th Edition).

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