CASE DESCRIPTION:-

Sesla is an Australian company established in 2004 by Melon Tusk as an EV research and manufacturing firm. Sesla spent over 10 years researching EV technology that was more efficient than existing tech to address the growing environmental sustainability concerns.

The company launched its first car in 2015 which was more stylish, more efficient, and faster than all existing EVs. The company’s proprietary EV engine tech made it a market leader within 3 years of launching as it gained over 50% of the market within 15 years of incorporation.

With continued research in EVs, the company has now further developed its trademark EV engine to make it more efficient while also introducing products in the LCV and HCV verticals. Today, after 20 years of incorporation, the company has a global market share of over 60%!

However, competition is now catching up with the company. Chinese manufacturers like ZYD and MIO are posing a threat to the company as their devalued currencies are resulting in a price war in major markets, threatening the company’s market share. Thus, the company is now planning to raise $10 billion to invest in new factories and improve its operating processes. The company has retained earnings of $2.3 billion available for deployment.

Thus, the company has now approached your investment bank, Debit Tuisse, to ask for your expert advice on how to raise the funds. This is the biggest assignment that your bank has ever undertaken. How will you solve it?

OPTIONS:-

There are three ways the company can raise the funds needed:

1. Initial Public Offering (IPO)

  • Sesla can go public by offering new shares to the public through an IPO. Considering its size, it will certainly receive a positive response from investors.
  • IPO costs are estimated to be 8% of the money raised.
  • Share demand is expected to be 1 billion at a price of $10 per share.
  • Underwriting fees are estimated to be 4% of the cash raised.

2. Private Placement

  • Sesla can raise funds by privately issuing additional shares to a small group of accredited investors. According to your observation, there are several investors ready to invest in the company.
  • Private placement costs are estimated to be 11% of the capital raised.
  • Share demand is expected to be 2 billion shares at $5 apiece. 

3. Debt Financing

  • Finally. Sesla can obtain debt funding by issuing fixed-rate corporate bonds. These are interest-paying bonds that must be repaid after 5 years.
  • Debt issuance costs are estimated to be 5% of the cash raised.
  • The bond coupon rate is 5.5% each year.

QUESTIONS:-

  • What is the best way to raise funds?
  • If more than one way must be used, what is the optimal mix that the company should employ to ensure the lowest WACC?

ANALYSIS:-

IPO:

  • IPO: $10 billion in capital raised.
  • IPO costs: $800 million (8% percent of $10 billion).
  • Underwriting fees: $400 million (4% of the total amount raised).
  • Total cost = $1.2 billion (12% of funds raised) 
  • The net proceeds are $8.8 billion.
  • 1 billion new shares ($10 billion /$10 per share) are issued.

Private Placement:

  • $10 billion in capital raised.
  • The cost of a private placement is $1.1 billion (11% of $10 billion).
  • The net proceeds were $8.9 billion.
  • 2 billion new shares (10 billion /$5) are issued.

Debt funding:

  • $10 billion in capital raised.
  • The cost of issuing debt is $500 million (5% of $10 billion).
  • Bond coupon payments: $550 million per year (5.5% of $10 billion).
  • Total interest payments over five years: $2.75 billion.
  • The total repayment amount over five years is $12.75 billion.

CONCLUSION:-

1] Every method of raising funds has its respective Pros and Cons:

  • When considering an IPO, the company can involve public funds in itself while gaining higher share valuations and improving its brand value. However, that is followed by greater scrutiny, increased compliance responsibilities, and managing short-term shareholder wealth along with long-term plans.
  • In the case of private placement, the company can avoid regulatory scrutiny and compliance issues while raising funds at a significantly greater speed. However, investors generally buy at lower valuations while demanding higher returns, which could be detrimental to the company’s growth.
  • For debt, the company can avoid diluting control while getting tax benefits and improving its credit score. However, the company will face regular interest payments and there are restrictions on the usage of such funds.

In this case, the company is at a disadvantage when considering Private Placement. Its valuation is 50% lower than that of an IPO, indicating that the company would be giving up twice as much control to private investors if it were to consider Private Placement. Therefore, even though the company is raising $100 million more in Private Placement than in an IPO, the lower valuation and significant dilution in control are unfavourable, hence ruled out.

Thus, the best practice would be to employ a combination of IPO and Bonds which ensures that the company raises the required funds at the lowest cost while retaining the highest possible control.

2] Therefore, to ensure the best fundraising plan, we will use both Debt and Equity funding means and raise the required amount. For the sake of simplicity, let's consider the following five mixes:-

  • 0:100 = Equity:Debt
  • 25:75 = Equity:Debt
  • 50:50 = Equity:Debt
  • 75:25 = Equity:Debt
  • 100:0 = Equity:Debt

Let’s break down the cost for these alternatives:-

1] $10 billion in Debt.

Cost: ($10 billion X 5%) + ($5 million X 5.5% X 5 years)

= $500,000,000 + 2,750,000,000

= $3,250,000,000

2] $2.5 billion by Equity and $7.5 billion by Debt.

Cost: ($2.5 billion X 12%) + ($7.5 billion X 5%) + ($7.5 billion X 5.5% X 5 years)

= $300,000,000 + $375,000,000 + $2,062,500,000

= $2,737,500,000

3] $5 billion by Equity and $5 billion by Debt.

Cost: ($5 billion X 12%) + ($5 billion X 5%) + ($5 billion X 5.5% X 5years)

= $600,000,000 + $250,000,000 + $1,375,000,000

= $2,225,000,000

4] $7.5 billion by Equity and $2.5 billion by Debt.

Cost: ($7.5 billion X 12%) + ($2.5 billion X 5%) + ($2.5 billion X 5.5% X 5 years)

= $900,000,000 + $125,000,000 + $687,500,000

= $1,712,500,000

5] $10 billion by Equity

Cost: ($10 billion X 12%)

= $1,200,000,000

Thus, according to the calculations made above, the company should consider raising the entirety of the $10 billion by going public. This will allow the company to raise the funds at the lowest possible cost while taking advantage of higher valuations when compared to debt alternatives, and retain more control in the company. Although the company will have higher compliance responsibilities and reporting requirements, the company will stand to gain more from the IPO.

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[Disclaimer: This case study is entirely hypothetical and unrelated to real-world situations. It's designed for educational purposes to illustrate theoretical concepts and potential scenarios within a given context. Any similarities to actual events or individuals are purely coincidental.]