SILICON VALLEY LAW GROUP ASSOCIATION FOR CORPORATE GROWTH BUSINESS GROWTH SERIES 2004 FINANCING TRENDS IPO’S, SECONDARY OFFERINGS, PIPES AND OTHER FINANCING STRATEGIES JAMES C. CHAPMAN SILICON VALLEY LAW GROUP ROBIN GRAHAM VICE PRESIDENT NEEDHAM & COMPANY, INC. CHRISTOPHER W. ALLICK INSTREAM PARTNERS MARCH 17, 2004
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SILICON VALLEY LAW GROUP ASSOCIATION FOR CORPORATE GROWTH BUSINESS GROWTH SERIES 2004 FINANCING TRENDS IPO’S, SECONDARY OFFERINGS, PIPES AND OTHER FINANCING.
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SILICON VALLEY LAW GROUP
ASSOCIATION FOR CORPORATE GROWTHBUSINESS GROWTH SERIES
2004 FINANCING TRENDSIPO’S, SECONDARY OFFERINGS, PIPES AND
OTHER FINANCING STRATEGIES
JAMES C. CHAPMANSILICON VALLEY LAW GROUP
ROBIN GRAHAMVICE PRESIDENT
NEEDHAM & COMPANY, INC.
CHRISTOPHER W. ALLICKINSTREAM PARTNERS
MARCH 17, 2004
SILICON VALLEY LAW GROUP
Large and Growing Market Opportunity
Unique and Proprietary Technology
Blue Chip Customer Base
Strong Revenue and Earnings Growth
Management Team with Proven Ability to Execute
Numerous Areas for Future Expansion
What do Investors Look for in Companies Going Public?
Requirements for an IPO
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SILICON VALLEY LAW GROUP
What Drives Valuation?
IPOValuation
External Drivers• Broad equity market strength
• Comparable performance
• Quality of IPO performance
• Volume of IPO market
• Inflows into mutual funds
Internal Drivers• Size of market opportunity
• Growth rate
• Profitability
• Future profit streams
• Quality of company
• Quality of management
• Deal structureSupply / Demand
Considerations
Roadshow
Liquidity
Float
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•The equity market recovery began in April 2003
•Now showing some signs of being overheated and may require a pullback to get to a more sustainable pace and justifiable valuations.
•Critical Factors for economic recovery:
• Fiscal stimulus, high levels of liquidity, low interest rates, an expanding economy, corporate growth (particularly in earnings) and an improvement in consumer confidence
• …but much of the resulting ebullience has been priced into stock prices
•The equity calendar continues to build strongly.
• Most follow-on offerings will be completed although their successes may vary
• Some IPOs have performed well recently and some have faltered, but all will be held to a demanding standard.
Overview of the Equity Capital Markets
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Quarter Ended
March 2003 June 2003 September 2003 December 2003
Index P/E(2) Index P/E(2) Index P/E(2) Index P/E(2)
Dow Jones Industrial Average 7,992.1 19.3x 8,985.4 20.4x 9,275.1 20.9x 10,453.9 22.3x
S&P 500 Index (Reported Basis) Dow Jones Industrial Average Russell 2000 NASDAQ 100 Index
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Overview of the Equity Capital Markets
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Overview of the Equity Capital Markets
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(1) From January 1, 2000 through March 1, 2004.Source: CommScan EquiDesk
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Overview of the Equity Capital Markets
(1) From January 1, 2000 through March 1, 2004.Source: CommScan EquiDesk
Total Public Equity Offerings Priced
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IPO Volume
Technology offerings dominated the new issue market in 1999 and 2000, then declined significantly in concert with the drop in the technology equity markets. Over the past few years the only areas of strength in the market were in the Financial Services and Real Estate sectors
IPOs priced in 2003 experienced an average 10.9% gain on their first day of trading and have continue to perform well averaging a 33.0% gain since the offering.
As a result of this strong performance the market is becoming more receptive to IPOs from issuers in a broad range of markets including an expected surge of activity in the technology offering market.
Initial Public Offering Volume by Sector ($ in Millions)Initial Public Offering Volume by Sector ($ in Millions)Initial Public Offering Volume by Sector ($ in Millions)Initial Public Offering Volume by Sector ($ in Millions)
Citigroup (Salomon Smith Barney)CS First BostonGoldman SachsLehman BrothersMerrill LynchMorgan Stanley
Citigroup (Salomon Smith Barney)CS First BostonGoldman SachsLehman BrothersMerrill LynchMorgan Stanley
Regional Retail, Institutional or Emerging Growth FirmsRegional Retail, Institutional or Emerging Growth Firms
A.G. Edwards (St. Louis)Adams Harkness & Hill (Boston)Friedman Billings & Ramsey (Washington D.C.)Harris Nesbitt GerardJanney Montgomery Scott (Philadelphia)Jefferies Group KeyCorp / McDonald & Company (Cleveland)Morgan Keegan (Memphis)Pacific Growth Securities (San Francisco)Raymond James Financial (Tampa)SunTrust Robinson Humphrey (Atlanta)Stephens Inc. (Little Rock)Robert W. Baird (Milwaukee)Wachovia Corporation (Charlotte)Wells Fargo Securities (San Francisco) William Blair (Chicago)
A.G. Edwards (St. Louis)Adams Harkness & Hill (Boston)Friedman Billings & Ramsey (Washington D.C.)Harris Nesbitt GerardJanney Montgomery Scott (Philadelphia)Jefferies Group KeyCorp / McDonald & Company (Cleveland)Morgan Keegan (Memphis)Pacific Growth Securities (San Francisco)Raymond James Financial (Tampa)SunTrust Robinson Humphrey (Atlanta)Stephens Inc. (Little Rock)Robert W. Baird (Milwaukee)Wachovia Corporation (Charlotte)Wells Fargo Securities (San Francisco) William Blair (Chicago)
Emerging Growth Firms NowOwned by Major Commercial BankEmerging Growth Firms NowOwned by Major Commercial Bank
Banc of America Securities (Montgomery)J.P. Morgan (Hambrecht & Quest)CIBC World Markets (CIBC)Deutsche Bank (Alex. Brown & Sons)RBC Capital Markets (Wessels, Arnold)SG Cowen
Banc of America Securities (Montgomery)J.P. Morgan (Hambrecht & Quest)CIBC World Markets (CIBC)Deutsche Bank (Alex. Brown & Sons)RBC Capital Markets (Wessels, Arnold)SG Cowen
Major Bracket Institutional FirmsMajor Bracket Institutional Firms
8,001 100.0% 345,415$ 100.0%1All private placements since 1995.Source: PlacementTracker.com
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PIPE Market
In early 1990s, PIPEs were primarily opportunistic financings for small and/or distressed, high-growth companies
Often times structured as “death-spiral” or “toxic” transactions
After market collapse, confluence of factors has legitimized PIPE market Dearth of capital for prematurely public, but worthwhile companies
• Mutual fund restrictions on minimum share price, trading volume and market cap precluded ownership
Crossover VCs and private equity firms view select public companies as startups that went public too soon
• Emergence of sub-$100 million small- and micro-cap hedge funds More favorable terms, higher volume and diversification
• In 2003, healthcare and technology/communications issuers accounted for approximately 42% of proceeds raised, down from approximately 65% in 1998
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PIPE Trends
PIPE transaction volume has grown by over 29% since 1995 114 PIPEs for proceeds of $1.4 billion in 1995 881 PIPEs for proceeds of $11.6 billion in 2003
Pricing Trends Recent market recovery has created a more favorable environment for issuers
Common stock at a discount prevalent structure vs. convertible preferred Typical discount has narrowed from 20-25% to 20-15%
• Size of discount dependent on several factors, including:– Liquidity (average daily trading volume)– Enterprise value– Profitability– Transaction size
PIPEs now accepted and even rewarded in the market No longer the “last resort” financing option
Larger private placement candidates six months ago now considering secondary or follow-on offerings
PIPE market expected to remain robust for small-and micro-cap issuers
Recent market recovery has led to generally more favorable terms for issuers.
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SILICON VALLEY LAW GROUP
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* A “reverse merger” is a method by which a private company goes public. In a reverse merger, a private company merges with a public shell company thereby “going public” without having to traverse the long and laborious undertaking of an IPO.
* Although the public entity is the legal “surviving” company in a reverse merger, the private company shareholders usually own a vast majority of the public company
shares (usually 90% or more) as a result of the merger.
* The private company normally will change the name of the public corporation (often to its own name).
* The private company’s officers and directors usually become the officers and directors of the public company.
REVERSE MEGERS
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2004 FINANCING TRENDS
EXAMPLES OF SUCCESSFUL REVERSE MERGERS
* Armand Hammer, is generally credited with having invented the “Reverse Merger”. In the 1950s, Hammer invested in a shell company into which he merged Occidental Petroleum.
* In 1970 Ted Turner completed a reverse merger with Rice Broadcasting, which went on to become Turner Broadcasting.
* One of the dot com fallen angels, Rare Medium (RRRR), was a $2 stock in 1998 which found its way over $90 in 2000.
* Acclaim Entertainment (AKLAM) merged into non operating Tele-Communications, Inc. in 1994.
* Waste Management, the market leader in waste disposal.
* Blockbuster Video, the market leader in DVD and video rentals.
* RAE Systems, Inc. a leader in environmental and security sensors.
SILICON VALLEY LAW GROUP
2004 FINANCING TRENDS
ADVANTAGES OF GOING PUBLIC BY MEANS OFA REVERSE MERGER
A. The Advantage of “Going Public”
* Active trading market allows shareholders to obtain liquidity.
* Historically, capital has been easier to raise for public companies because the stock has an easily ascertainable market value and can be traded.
* A public corporation may be used for special purposes, such as qualifying as a category two company for overseas offering pursuant to Regulation S.
* Because of the liquidity factor, publicly traded companies generally have higher valuations than private companies of the same characteristics.
* Unlike privately held companies, the existence of a public market for the shares of a company allows it to use its shares as currency to acquire other companies.
* Public companies are better able to stock based compensation such as stock options to attract and retain the best employees.
SILICON VALLEY LAW GROUP
2004 FINANCING TRENDS
ADVANTAGES OF GOING PUBLIC BY MEANS OFA REVERSE MERGER
B. The Advantages of “Going Public” through a Reverse Merger
* The costs of a reverse merger transaction are significantly less than the costs required for an IPO. The cost of completing a reverse merger including the acquisition of the public shell ranges from $100,000 to $300,000 with many variables. The cost of an IPO ranges from $200,000to $1,000,000 again with many variables.
* Additionally, reverse mergers can be completed quicker than IPO’s. Generally, reverse mergers can be completed in less than three to four months. An IPO can take up to twelve to eighteen months from inception to completion.
* Another major disadvantage of IPO’s are the current requirements placed on IPO candidates by the investment banking community. Although these requirements vary from underwriter to underwriter, an IPO candidate should have at least $25-$80 million in annual revenue; six quarters of profitability, and a growth rate of 20-40% annually.
SILICON VALLEY LAW GROUP
2004 FINANCING TRENDS
DISADVANTAGES OF A REVERSE MERGER
A. The Disadvantages of “Going Public”
* Higher visibility. A public company is essentially under a microscope. There is little confidentiality. All material transactions and contracts become public information.
* The public reporting requirements, need for audited financial statements, compliance with the plethora of SEC rules and regulations and investor relations activities substantially increase the cost of doing business.
* Public companies have long been accused of having a short term business focus. Management often is consumed with the daily price of the companies and manage the business in response.
* The public reporting process and the need to maintain interest in the company takes a tremendous amount of management's time and energy.
* Increased liability. In 2002 there were 259 securities class action lawsuits and in 2003 there were 211. The average settlement in 2001 and 2002 was $16.6 and $24.3 million respectively.
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2004 FINANCING TRENDS
DISADVANTAGES OF A REVERSE MERGER
B. The Disadvantages of “Going Public” Through A Reverse Merger
* Lack of Liquidity. “Public Company Trap”, Orphaned Public Company”, “Twilight Zone”.
* “Pump and Dump” Schemes. Practice by shady promoters who take a stock that has been trading for pennies, merge it into a business that has at least the façade of respectability and a presence in a market that is perceived as hot, hype like hello, sell off as many shares as possible, and exit before the stock price drops.
* “Toxic Convertibles” or “Toxic Debentures”.
* No New Capital.
* Less Due Diligence and Accountability.
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2004 FINANCING TRENDS
CRITICAL SUCCESS FACTORS
* Good Management Team
* Combine the reverse merger with a financing event.
* Develop and implement a strategy for creating a liquid market for the shares.
Elements of this strategy include a financial communications program.
The company must identify the market makers and brokers that trade in the small cap/micro cap market.
Develop relationships with the fund mangers of small cap/micro investment funds and interest them in the company’s story.
* Develop a reputation for integrity.
* Good business plan the ability to execute it with a few resources and infrastructure.
* The company must also hire quality auditing and law firms.