Solo Class Project QUESTIONS
This project carries four questions. The first question carries 50% of the total solo-project credit; the second and third questions carry 15% each; the last question carries 20%.
1. Answer the following questions after studying the preliminary prospectus of the Biotech company, Mineralys Therapeutics, and the two attached newspaper articles related to its IPO. Mineralys went public on February 10, 2023 with a final IPO offer price of $16.00 per share. You can dig up additional information on Mineralys and its IPO and use this additional information to answer these questions as well (though your answer should be self-contained and cannot rely on someone else’s calculations: you need to give ALL supporting calculations for any quantitative questions such as the valuations of the firm, etc.)
(i) Was Mineralys undervalued or overvalued at the time of IPO (i.e., at the final offer price)? Justify your answer with various calculations. (Useful calculations would include computing the intrinsic value of the company using either comparable valuation or cash flow valuation, or both). You may use various IPO web sites (like IPOscoop.com, Hoover.com or Renaissance Capital) linked to the course web site to produce (obtain) additional information helpful in doing various calculations, though you need to provide all these calculations yourself.
(ii) Mineralys Therapeutics initially filed to go public mentioning that its offer price would be between $14 to $16 per share (“initial filing range”). Assuming that you are working for an institutional investor potentially interested in investing in the IPO, could you prepare a brief (one page) “Investing note” on Mineralys Therapeutics, explaining why you think this IPO is a good investment (or why it is not a good investment) if shares are offered with an offer price at or within the initial filing range. You can mention the nature of the firm’s business, its competitors, potential risks, how the firm has been financed so far, or any other information you may wish to include. In preparing this investing note, feel free to use any information you can find (i.e., any information in addition to that in the prospectus).
(iii) At the very beginning of their prospectus, Mineralys Therapeutics refers to itself as an “emerging growth company.” Could you explain what this means? How do you think this classification affected the Mineralys IPO?
(iv) One of the attached articles mentions the following: “Shares of Mineralys opened at $21.10 at around 11:15 a.m. ET, quickly reaching a high of $21.98 before sliding to a low of $20.50. The stock recently changed hands at $20.72, up 30% from its IPO price, at approximately 12:10 p.m. ET.” Could the fairly high initial return have been predicted in advance (to some extent)? What would be the indicators you would use to make such a prediction?
(v) What fraction of the IPO equity offering is “primary” and what fraction is “secondary”? Give details (numerical fractions).
(vi) The first page of the IPO prospectus says: “The underwriters may also exercise their option to purchase up to an additional 1,800,000 shares of common stock from us, at the initial public offering price, less the underwriting discount, for 30 days after the date of this prospectus.” This provision is called the “green show” or overallotment option.” Was this provision likely to have been exercised in the case of Mineralys Therapeutics’ IPO?
Why or why not (i.e., why would it have been exercised or not exercised)? What will be the effect of the overallotment option on underwriters’ incentives?
(vii) What accounts for the timing of Mineralys Therapeutics’ IPO? Comment on the timing from the point of view of the equity market as well as from the point of view of the firm’s life cycle. Hint: While this article is not required for the exam, the advanced reading, “The Going Public Decision and the Product Market,” by Chemmanur, He, and Nandy(posted under IPOs on the course website) may be worth a quick look before answering this question (you may also want to keep our case discussion(s) in mind).
(viii) Mention the names of the main underwriters (book runners) of Mineralys Therapeutics IPO. Comment on this choice by Mineralys of its underwriting team (top book runners).
Is this choice appropriate?
(ix) Calculate the compensation package (underwriting discount) given to the underwriters of Mineralys Therapeutics IPO? Is this excessive? Why or why not?
(x) Comment on Mineralys Therapeutics’ choice of venue (exchange) to list its shares. Is there something special about this listing site? Is this choice of listing appropriate for the company?
(xi) Was Mineralys profitable at the time of the IPO? How does it being profitable or not currently affect its attractiveness to potential investors?
(xii) You work for a Boston based mutual fund that received a significant IPO allocation in Mineralys Therapeutics, Inc. As a researcher advising the portfolio manager, you are asked to arrive at a trading strategy for the shares your fund received in the IPO. Would you recommend that your fund flip out of the IPO immediately? What trading strategy would you recommend? You should give details, like the percentage of the IPO allocation you recommend your portfolio manager sell (if any) during what horizon, until the entire IPO allocation is exhausted. Briefly give the rationale for your advice, based on our class discussions, the available empirical evidence etc. (An advanced reading on the course website by Chemmanur, Hu, and Huang (2010) may be helpful to answer this question, though this reading is not required for the exam.)
(xiii) You work for a mutual fund which invests primarily in the shares of firms going public, in an advisory capacity. While the fund’s portfolio manager is aware that IPOs underperform in the long run, its strategy is to cherry-pick good IPOs, and invest in them in the aftermarket (i.e., after the start of trading in the IPO firm’s shares) for a three to five-year horizon. Would you advice the portfolio manager to invest in the shares of Mineralys Therapeutics as of today (i.e., in the secondary market)? Discuss specifically what the facts are which prompt you to advice investing or not investing (you can mention the strengths and weaknesses of Mineralys Therapeutics as an investment, including its age at IPO, product portfolio, industry characteristics, and product market competition), before giving your overall final recommendation regarding whether or not to invest. Further, if you do recommend investment, when do you recommend your mutual fund invest: i.e., how many months after the IPO? NO CREDIT WILL BE GIVEN FOR A SIMPLE YES OR NO ANSWER WITHOUT JUSTIFICATION OR AN ANSWER WITHOUT A FINAL RECOMMENDATION.
2. Maine Industries, a large corporation, is currently considering the private sale of its high volume/low margin/low growth Hampshire unit to another firm. Your task is to estimate the price that Maine Inc may be able to get for its Hampshire unit as of early (March) 2023. You have available the following operating projections:
Hampshire Unit: 2023-2027 Projections (millions $)
2023 2024 2025 2026 2027
Sales 4,700.5
Growth rate of sales 5.0% 5.0% 5.0% 5.0% 5.0%
Cost of sales 72.5% 72.5% 72.5% 72.5% 72.5%
Operating expenses 26.9% 26.8% 26.7% 26.6% 26.6%
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EBIT 28.2
Depreciation 30.6 36.2 40.9 41.1 37.0
CAPEX + WC increases 45.0 49.5 50.0 45.0 40.0
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You estimate that the Hampshire unit can be financed with 50% debt at 12%, that its equity beta for that leverage will be 0.9, and that the corporate tax rate is 40%. You have observed that the long-term Treasury yield is 4.22%. The equity risk premium over long-term Treasuries for small-cap firms is 6%. Finally, an examination of companies comparable to the Hampshire unit yielded an average EBIT multiple equal to 8.5 times current EBIT. (Hint: As a prelude to computing the value of the Hampshire unit, you need to compute the free-cash flow of the Hampshire unit for the years 2023 through 2027.)
3. Assume that a VC makes an investment of $ 200 million in a firm’s project. This project has 40% probability of being highly successful and 60% probability of having a mediocre outcome. The cash flows for each scenario are projected to be as follows:
Highly Successful Scenario: Cash flows of $70 million, $340 million, and $1000 million, respectively, in year 1, year 2, and year 3.
Mediocre Scenario: Cash flows of $50million, $60 million, and $200 million, respectively, in year 1, year 2, and year 3.
(a) Assume first that the VC takes common stock in the firm in return for its investment.
How much of the equity should he demand if his expected rate of return is 40%.
(b) As an alternative to giving the VC common stock, design a combination of a bond and a warrant to be given to the VC that you believe will improve the entrepreneur’s incentive to work hard to achieve the “highly successful” scenario. You should give the details of the proposed cash flows to the bond at each date; and the fraction of the firm’s equity that the warrant should be convertible into at time 3.
(c) What are the advantages of securities such as a bond and warrant (or a similar security used in practice, namely, convertible preferred shares) being offered to the VC by startup firms (instead of offering common stock to the VC)?
4. Answer the following questions after reviewing the attached articles (as well as the required or even advanced readings) on venture capital, IPOs, the exit strategies of successful private firms, etc. and the insights from our class discussions of venture capital financing and IPOs. For each question (subpart), give your answers carefully in four or five lines each (no calculations are necessary, but give the detailed reasoning behind your answer for each question).
(i) Name two alternatives to traditional venture capital (VC) firms (independent venture capital firms organized as private limited partnerships) that are available to early stage firms in the US. for raising private equity financing? List the advantages and disadvantages each of these two alternative sources of private equity financing compared to raising financing from traditional VC firms?
(ii) Read the attached article from the Wall Street Journal (dated February 20, 2023) mentioning that venture fund raising from limited partners hit a nine-year low in the last (fourth) quarter of 2022. What are the factors that may have contributed to this venture financing slowdown? What do you think are the implications of this scarcity in investment by limited partners in venture funds for the valuation of early versus late stage start-up firms? Finally, suppose a startup firm did get funding from venture capitalists during the fourth quarter of 2022. What do you think the success probability of such a firm compared to a startup firm that got funding during the fourth quarter of 2021 (when venture capital funding was more plentiful)?
(iii) Read the attached article from the Wall Street Journal about the March 10, 2021 “direct listing” on the NYSE of the video-gaming firm Roblox Corporation. A second attached WSJ article (December 22, 2020) talks about a rule-change made by the New York Stock Exchange (NYSE) that facilitate raising capital through such a direct listing (such capital raising through direct listing was previously not allowed). How would such a direct listing differ from a regular (traditional) IPO? What are the possible advantages and disadvantages of such a direct listing over a regular IPO for the firm involved? If direct listings such as that of Spotify Technology, Slack Technologies, and Palantir Technology become more popular, how will this affect the structure of the investment banking industry in the US?
(iv) Read the attached news article (from the Wall Street Journal, January 23, 2021) on the popularity “SPACS” (sometimes called “SPAC Mergers” or “Blank Check Acquisition Companies”) as a means for private companies to go public and their popularity with investors during 2020 and 2021. What are the advantages of SPACs relative to traditional IPOs as a means of going public for private firms? What are the dangers, if any, for retail investors from investing in firms that went public through SPACs? In answering this question, you may also benefit from reading two more recent attached articles from the Wall Street Journal (from November and December 2022, respectively) on the actual performance of many SPACs, and the returns actually achieved by large “sponsoring investors (sponsors)” and retail investors from investing in firms that went public through SPACs. Hint: If you want to dig a bit deeper into SPACs, you can also read the advanced reading on SPACs by Gahng, Ritter, and Zhang posted on the course website under the first session on IPOs.
(v) Many of the firms that went public in 2020 and 2021 (either through SPACS or through traditional IPOs) have fallen on hard times, in terms of their secondary market stock price falling below the IPO offer price and their poor post-IPO accounting (operating) performance as well as their stock returns after IPO. As the attached Wall Street Journal article (February 19, 2023) mentions, many of these firms are in the process of being “bought out” by private equity buyout firms at a price lower than their IPO offer price. What does this say about the optimal timing of the going public decision by firms (and the advantages and disadvantages of going public versus remaining private)?
