Study co-authored by Professor Raghavendra Rau of Cambridge Judge Business School examines why some firms go public through initial public debt offerings rather than the more publicised initial public offerings of equity.
The business-news headlines are often filled with the names of high-profile firms that go public through an initial public offering (IPO) of equity – among them Google in 2004, Facebook in 2012 and Twitter in 2013.
Less publicised are firms choosing to go public through a debt issuance – an initial public debt offering (IPDO).
Yet, as an available option, it could also affect the IPO choice. Firms choosing the traditional IPO option could be systematically different from firms choosing an IPDO option. This raises the possibility that some often-found characteristics of IPOs – such as underpricing (an initial equity offering price that quickly rises in the markets because investors believe the firm is undervalued at the offer price) and their subsequent poor long-horizon performance are biased because of these underlying differences.
A study co-authored by Raghavendra Rau, Sir Evelyn de Rothschild Professor of Finance at Cambridge Judge Business School, looks at why companies go public through debt rather than equity, and some of the characteristics of such firms.
About a quarter of such IPDO companies eventually also conduct an IPO, and they tend to face lower underpricing than companies that do not have public debt at the time of issuing equity.
The study looked at a sample of 635 IPDOs from 1987 to 2016, comparing them to contemporaneous IPO firms. About 18 per cent of sample firms that went public chose the IPDO route, raising about 45 per cent of the total amount raised by IPO firms.
The study, published in the journal Critical Finance Review, was co-authored by Denys Glushkov of Acadian Asset Management, Ajay Khorana of Citigroup, Raghavendra Rau of Cambridge Judge Business School, and Jingxuan Zhang, who was a research assistant at the Cambridge Centre for Alternative Finance at Cambridge Judge Business School.
Professor Raghavendra Rau discusses some of the study’s findings:
Firms that pursue IPDOs tend to be older and more established firms. As a result, their assets are more readily amenable to financial statement analysis than other private firms that choose the IPO route – and this is something that bond investors, especially, appreciate. Many of the post-issuance contractual rights of lenders are written in terms of financial statement variables, and firms that are more easily able to disclose their important performance data through financial statements have advantages in the debt markets.
IPDO firms are more likely to be backed by financial sponsors such as private equity and venture capital firms. This suggests that ownership structure also matters when it comes to attracting investors through IPDOs. Private equity owners usually have a predilection for debt over equity, and this shows up in their going-public choice.
Only a tiny one per cent of the IPDO firms had faced bankruptcy or liquidation by the end of our sample period in 2016, and only two per cent went private again.
The median IPO underpricing of IPDO firms that eventually issued public equity is less than a third of pure IPO firms. In addition, the amount raised through eventual equity offerings by IPDO firms is double, and they face lower fees by underwriters. There is less information asymmetry surrounding such firms, because subsequent equity investors have a public track record to draw on: the financial statements released by the IPDO firms are valuable in establishing firm quality.
IPDO firms had a median age of 10 years, compared to five years for IPO firms from the same year or industry, with far greater assets than industry-matched IPO firms. With their reduced levels of information asymmetry, more mature firms find it easier to increase investor confidence, and this is reflected in their choice of market in going public.