Case Study on Pearson Corporation

The Case Study on Pearson Corporation

Value of the New Shares for the IPO

The value of financial assets traded in the market is fixed by the interplay of demand and supply. This canon does not exempt newly issued stocks because they sell for any price that a buyer is willing to pay. The best market analysts are professionals at the valuation of stocks; they work out the value of a stock. If the stock is being sold at a discount from what analysts view as its value, they will buy the stock and retain it until they can trade it for a value that is close to, or above the price that they think the stock is worth. IPOs (Initial Public Offers) are special kinds of stocks because they are freshly floated. The companies that issue them have not operated beforehand on an exchange and are less comprehensively evaluated compared to those companies that have been in business for several years. Some people argue that the absence of records on the past share prices presents a chance for purchases while others are of the idea that since IPOs have not yet undergone investigation and analysis by the market, they are highly risky compared to stocks with a record of undergoing evaluation (Sjostrom Jr and William 549). Therefore, the determination of the correct issue price for newly traded shares is a critical undertaking for companies. In the case of Pearson, the company should calculate the best value for its shares through the Gordon Growth Model.

Where P is the Value of the stock

E is the earnings of the company

G is the company’s constant growth rate

K is the company’s risk-adjusted discount rate

D is the company’s dividend payment

K= Rf+ (Rm-Rf) Be                   Rf- risk free rate

Rm-market rate

Be- beta factor

K=3.9%+ (10.74%-3.9%) 1.58=14.707%

P=16%*9.8% + 0.66         = 5.19

(14.707%) 2   14.707%

Advantages of Both Best Efforts and the Underwritten Deals Methods Public Offering        

All public companies employ either best efforts or underwritten deals for marketing their Initial Public Offers. The best-efforts method of going public involves the underwriters (investment bankers) acting as agents of Pearson Corporation, using their best efforts in selling securities on behalf of the company. The investment bankers would not be committed to buying any of the securities issued by Pearson and have not been bought by the public.

Since the company is interested in raising more funds through the release and sale of new shares to the public, an investment bank like George Zan’s bank would help in the process of offering technical expertise and clients to buy Pearson shares. When the company uses an investment bank as its agent, the process of the IPO becomes cheaper compared to attempting to sell securities to the public directly. George Zan’s investment bank will help John in determining the amount of money that will be required for offering, the security to sell, unique features it might bear, and the price that the company would sell the security.

The best efforts also make sure that agents provide other services like risk management, and serve the purpose of the principal in lieu of the agent in share transactions. This method is highly flexible since sales can be applied on an agency or principal basis, and conditions of the issue between the company that is issuing its shares and the investment bank as the agent, including its timing at the discretion of the company.

The underwritten deals that are also described as the commitment of the firm, involves a situation whereby the Pearson Corporation and the investment bank make an arrangement of carrying out an underwriting where the bank will buy the new shares at a price that is already determined. The investment bank will then sell the shares to the public at a cost that is higher than the buying price in order to recover all the costs incurred in the sale.

It is important to note that, the investment bank is the principal and not an agent in this public offering. Pearson Corporation will get the promised amount of money even if the investment bank fails to sell all the shares. Thus, the bank takes an imperative risk in the commitment of a company by positioning itself as the market maker for the newly introduced shares. Besides, the responsibilities that are involved in the underwriting like determining the offer price, registration of securities with the Securities and Exchange Commission, and creation and control of a syndicate to help in selling the new shares pass to the investment bank.

Pearson Corporation stands to benefits from the good name that George Zan’s investment bank has in the market to attract customers for its shares. In a firm commitment underwriting, the company will already know at the time the registration statement takes effect, the amount of money that it stands to acquire from the offer. Firm commitment deals also ensure that there is little involvement of the executive since it does not require any roadshows but only minimal prospectus formulation and release requirements (Kenji and Smith 1129-1135).

Disadvantages of both Best Efforts and the Underwritten Deals

An Initial Public Offer would have various chances of success or failure depending on the offering that a company chooses to use. Firm commitment underwriting is typically arranged only for larger corporations or in cases where agents or investment banks have seen signs of interest, an indication that the banks will be better placed to sell the securities that they would be obtained from the company. For the case of Pearson, adopting the firm commitment method will enable the company to sell shares at a reduced price compared to when they would have directly sold to the public.

However, using the best efforts offering consists of risks and time lags from the point of view of the company. Thus, it has to wait for investors to buy the shares and make payments for them in various allotments, unlike the firm commitment method where they will immediately get money after the agreement is settled with the investment bank. Best effort deals carry with them lost of risks of loss of money in case the shares are not fully subscribed to and during forfeiture of shares that have already been issued. Best efforts are costly means of marketing an IPO and managed by companies that deal in tentative securities of new and untested organizations.

The investment bank will try hard to sell all the shares of the new company but does not offer a guarantee for this. Hence, the company is faced with the threat that the bank may fail in seeking procurement of all the new securities, thereby cutting down the amount of money that Pearson may receive. Besides, the best methods point out that if the Securities and Exchange Commission cancels the public offer, the money that is already paid to the company by the investors must be refunded, and no more orders should be taken.

Under the best efforts method, all funds received from the Initial Public Offer go to the issuing company without the commission paid to the underwriters. Considering that the method of firm commitment involves the issuing company selling all its shares to an investment bank, which in turn sells to the public in exchange for profit, the company risks selling all its hard-earned benefits at a lower price to the intermediaries who would easily make profits from it. Despite the fact that this offering is secure, it puts a company at the risk of throwing lots of its revenues away if the offer turns out to be favorable (Kenji and Smith 1135-1137).

Commentary on the Best Method that should be adopted by the Company

Considering the current situation and performance of Pearson Corporation, it should adopt the best efforts method in conducting its Initial Public Offer. The company has received bountiful interests and based on the information on newspapers by the investment community, there is great potential in the securities of the company. Investment banks only agree to underwrite the securities of a given company if they are sure about their marketability and success of the IPO.

Based on the fact that one of the investment bankers called George Zans has made a call to John, there is an indication that the securities of the company are of value and in high demand in the market. Even though the best efforts method may be hit by some technical conditions that involve the engagement of experts and high floatation costs, the method would offer the best returns for the securities of the company. Pearson Corporation also has various characteristics that make it a promising investment window for many investors. John’s products are innovative and the investors consider the company as having good opportunities for success in the future. The availability of effective and competent management will make the future investors of the company to have confidence in the growth and sustainability of the company (Kanji and Smith 1137-1166).

Timing and Market Consideration for an IPO

An Initial Public Offer is an evolutionary experience for a company, thus, it is critical that its preparation and timing are given much consideration. The timing of an offering is among the key factors that should be considered by the chief executive of Pearson Corporation. In order to attain the best price for the securities of the company, there have to be favorable market conditions, and the company must also appeal to investors. The questions that should be raised by John concerning the timing of the IPO include whether there is a general conducive climate for the shares at that particular time, whether the automobile sector is being favored by the investment community, whether the market is flooded with related corporations from previous IPOs, and the market’s common risk margin.

With regards to these questions, Pearson Corporation seems to be on the right time for its IPO (Dunbar 60-70). The company’s director has been receiving several phone calls showing that the investment population is ready for the offering. Besides, Pearson Corporation is manufacturing more innovative automobile brands unlike other companies in the sector, hence, making it a more appealing investment opportunity for investors. In fact, even the figures of sales and earnings also indicate continuous growth of the company. Even though it has not been nationally recognized for a long time, it portrays a good long-term venture at a rational price-earnings ratio. The company’s financial data shows that sales and earnings have grown by 16% and 9.8% within five years.

Therefore, the company is better placed in having a successful IPO at this time based on the high demand in the market. The market searches for companies in sectors that can support favorable growth with the latest products and qualified management. Pearson companies unleashing their public offer after attaining status in their growth whereby most of their industrial, production, and sales threats have been significantly cut down. This paints a picture of a successful Initial Public Offer for the company owing to their appropriate timing (Dunbar 70-90).

Analysis and Recommendations

Before John pursues the path of declaring his company public through the IPO, he should look into the reasons for making that decision. According to several surveys carried out in the United States, below are the reasons for going public.

Executive Survey for the Most Significant Reason in Leading Your Company to Seek an IPO

Reasons for seeking IPO Percentage of executive respondents who consider the factor as most important
Fund market growth/acquisitions 38% 
Facilitate future financing 13% 
Enhance credibility/visibility with stakeholders  13% 
Provide an exit for VC/PE sponsors  19% 
Provide an exit for owner/shareholders 9%

The latest statement of financial standing and income statement and other financial information presented by the company suggest the fast growth exhibited by Pearson Corporation, and also its promising future prospects. The company’s dynamic and competent management further emphasizes this prospect of growth and the innovative and outstanding automobile brands manufactured. The competent team seems to have sufficient business competencies and experience for running a public traded company. After going through the financial statements of the company, the management seems to have been able to acquire proper discernment of the characteristics of the company and its activities. Therefore, the company should hire an expert IPO analyst to provide a reasonable valuation for the business (Cook et al, 35-45).

The valuation of the company should also look into other related companies in the industry which are already listed on the Securities Exchange in order to undertake an assessment on whether the value of the IPO is realistic or not. The timing of the offer is based upon more than just the decision of the underwriter regarding the environment in the market. For example, Pearson Corporation must undertake the furnishing of many years of audited financial records for the company and important business mergers. It may also be necessary to have unaudited interim financial statements, depending on the timing of the projected effectual date of the registration.

It is important for John and the management of the company to appraise the legal framework of the company with company tax and legal advice so as to evaluate the suitability of the corporate framework of the company at present. Major Securities Exchanges like the New York Stock Exchange have corporate governance record standards that must be attended to with regard to the IPO. These standards involve the purposes and obligations of internal audits, committee structure, conditions for independence, code of ethics, and business conduct requirements for employees and directors. It would be important for John to discuss the control standards of his company with his lawyers when setting up the public offering (Cook, Robert and Robert 45-61). John should find the best investment bank as the underwriter for his company by considering its reputation and charges. The chart below outlines the charges by various investment bankers.

Model Distribution of Investment Banking Fees

Public Offering Price   $20.00 per share

Manager’s Fee             $.25 – This is what the underwriting manager earns for all shares sold.

Underwriter’s Allowance $1.75 – The syndicate members get this for every share that it sells

Selling Concession         $1.00 – What the selling group receives per share

Reallowance                   $.50 – Per share for a broker or dealer who is not part of the deal or the

selling group.

Amount Received by Issuer $18.00 per share.

Works Cited

Douglas, Cook O., Kieschnick, Robert and Van Ness, Robert. . “On the marketing of IPOs.” Journal of Financial Economics 82.1 (2006): 35-61. Print.

Craig, Dunbar G. “The choice between firm-commitment and best-efforts offering methods in IPOs: The effect of unsuccessful offers.” Journal of Financial Intermediation 7.1 (2008): 60-90. Print.

Kenji, Kutsuna and Smith, Richard. “Why does book building drive out auction methods of IPO issuance? Evidence from Japan.” Review of Financial Studies 17.4 (2004): 1129-1166. Print.

Sjostrom Jr, William K. “Due Diligence Defense under Section 11 of the Securities Act of 1933.” Brandeis Law Journal 44 (2005): 549. Print.

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