Question

Glazer Drug Co. is the fourth largest generic drug company in the world, with annual sales of over $3 billion. It trails only Norvatis AG, Teva Pharmaceutical, and Mylan Labs in sales and profits. Its home office is in St. Louis, with its laboratories and sales outlets in the U.S. and 30 foreign countries, with the largest foreign operations in Great Britain and Australia. Its generic brand labels cover medication for heart disease, diabetes, acute infections, and many other ailments.

In the fall of 2012, the company decided to go public. Its investment banker was Aaron, Barkley, and Company.

Glazer Drug Co.’s most recent 12 month earnings were $150 million with one hundred million shares, providing an EPS figure of $1.50. After conducting a careful analysis of the generic drug industry, the investment banker decided a P/E of 25 would be appropriate, giving the stock a value of

$37.50. Allowing for the underwriting speed, the net to the corporation and selling stockholders was $36.68. The out-of-pocket underwriting expense was
$2 million on the 20 million chares that were to be sold to the public. Ten million of the 20 million shares in the IPO were new corporate shares and the remaining
10 million were shares currently owned by Larry Glazer, one of the founders of the company. The 10 million shares sold by Glazer represented 85 percent of his holdings.

On the day of the offering, the stock price shot up from $37.50 to $51.10 a share, and by January 1, 2013, the stock had reached a price of $61.75. Since no specific events involving the company had taken place, it appeared that the stock market had a favorable impression of the firm.

1. What was the percent underwriting speed?

2. Subsequent to the issue, by what amount would earnings per share be diluted?

3. What are the net proceeds to the corporation from the issue?

4. What rate of return would the corporation need to earn on the net proceeds to avoid dilution? Note: because of the relatively high P/E of 25, the answer is less than 5 percent. However, the P/E does not figure directly into the calculation.

5. Using the original earnings per share of $1.50, what would the P/E ratio be based on the stock price of $61.75 on January 1, 2013?

6. Should Mr. Glazer be happy about the pricing of the stock by the investment banker and the movement of the stock price after going public?

Answer 1

1). underwriting spread = (price per share-net proceeds per share)/price per share = (37.50-36.68)/37.50 = 2.19%

2). Total shares after issue = 100 + 10 = 110 million (since only 10 million new shares are issued)

New EPS = 150/110 = $1.36

Old EPS = $1.50

Dilution = 1.50 -1.36 = $0.14 per share

3). Net proceeds = (number of shares issued*net proceed per share) - underwriting costs = (20*36.68) - 2 = 731.60 million

4). For there to be no dilution, the total earnings are the new issue have to be based on the EPS of 1.50

Required earnings = 1.50*110 = 165 million

Required return = (required earnings - current earnings)/net proceeds

= (165-150)/731.60 = 2.05%

5). P/E = 61.75/1.50 = 41.17

6). A P/E of 25 gives a good share price to Mr.Glazer but the subsequent price rise would not make him much happy because he could have held onto his stock and sold later at a much higher price, to get more profit.