1. Why do you think JPMorgan and Merrill Lynch were selected to underwrite and book-run all $23.3 billion in financings (all debt, common stock, and convertible), instead of sharing the underwriting with additional firms?
JPMorgan and Merrill Lynch were selected to underwrite and book-run all of the financings because together they committed $6 billion in bridge loans and to underwrite the entire $17.5 billion in debt financing, plus $1.5 billion in credit lines. This created significant risk by aligning the interests of FCX and the two firms in terms of placing the debt and credit with other banks and institutional investors. Because this commitment was critical in facilitating ...view middle of the document...
The group also had to lead the effort to secure internal firm commitments and gain acceptance for associated capital charges. The group’s understanding of the market was crucial to the success of the acquisition.
3. Describe the forms of risk that an investment bank must consider in relation to acquisition and underwriting transactions. Describe what it means for a firm to set aside capital when it completes underwriting transactions.
The financing risk associated with an investment bank’s underwriting commitment in relation to financing an acquisition is called capital risk. Each time a bank agrees to fund an acquisition through an underwriting financing, it is responsible for arranging road shows between potential investors and the management of the issuing company and then for persuading investors to subscribe to the offering. A firm sets aside capital when it takes on an underwriting risk position.
If the firm bears market risk (which means that it will buy securities at the offered price if investors will not), the capital set aside could be significant. If the issuer bears market risk, the firm still has a small amount of risk, for which it must set aside a small amount of capital. Setting aside capital means placing cash in a risk-free security such as a treasury bond; this provides a return below shareholder’s equity return requirements, so it is considered an opportunity cost.
The risk that comes from associating the investment banking firm with the company for which it is raising capital or completing an M&A transaction is called reputation risk. Before an investment bank brings security investment ideas to investors or attempts to complete an M&Atransaction, it is important that the bank consider the quality of the companies it represents. If a company has had or is expected to have serious problems, an investment bank’s “brand” can be negatively affected, making reputation risk an important consideration.
4. Describe the role and importance of credit rating agencies in the Freeport-McMoRan transaction. Which group within an investment bank has the primary responsibility to work with companies regarding rating agency considerations?
Credit rating agencies were critically important to the transaction because they determined the credit rating associated with the post-acquisition capital structure of FCX. The higher the credit rating, the lower the cost of debt capital. This, in turn, could affect valuation of the company’s stock and return on equity. A ratings agency group within the debt capital markets group has the responsibility of advising corporate clients regarding the probable rating decision resulting from alternative financing structures. This group works closely with both the high-grade and leverage-loan teams within debt capital markets. With regard to the FCX acquisition of Phelps Dodge, the credit ratings on different debt portions improved due to the significant increase in cash flow and because Phelps Dodge...