Simplified Networking, Incorporated: A Case Study
Simplified Networking, Incorporated (SNI) was established in 1992 by Kenneth Gary, president and CEO. The company sells and installs network operating system software. Over the years, Gary became involved in his community which aided in building SNI a strong, positive reputation. In 2003, SNI began expanding into other regions and was an accepted leader in the industry in its state. Gary began considering a public offering of Simplified Networking, Incorporated’s stock. He decided to seek advice from an investment banker, Steve Jennings. Jennings informed Gary that it would be wise to consider issuing bonds and stocks. Jennings collected and summarized a wealth of information which would be pertinent to Gary’s decision about going public (Stretcher &Michael, 2005).
Advantages and Disadvantages of an SNI IPO
There are several issues which must be pondered before a business decides to go public. Current market conditions must be weighed heavily against the possible advantages and/or disadvantages of going public. Based upon Jennings’s expertise and his own knowledge, Gary must determine whether an initial public offering is the best alternative for Simplified Networking, Incorporated.
Simplified Networking, Incorporated exists within the fragmented computer networking industry which consists of small companies. Firm’s within this industry have diverse characteristics. Within the industry, the past five years have illustrated robust growth. However, public firm earnings have been “20% more volatile than a benchmark market portfolio such as the Standard and Poors 500 (Stretcher & Michael, 2005).” According to Jennings, “new bonds issued at par in today’s market (year-end 2003) would yield 6 percent (Stretcher &Michael, 2005).” Market demand for computer networking has remained steady (Stretcher &Michael, 2005).
There are a number of advantages to going public. The first is that, going public facilitates a business’s ability to raise new capital, and public markets usually earn more money than the private markets. Another advantage is that shareholders may gain liquidity on their shares which will allow the shareholders to “diversify their investment portfolios (Emery, Finnerty, &Stowe, 2011).” Going public may also provide the benefit of creating a visible market value in the business. Also, going public typically amplifies the business’s flexibility in equity financing. Finally, when a business goes public it must meet specific standards from investment bankers. When a firm meets these standards it usually means that the business is of good standing and reputation (Emery, et al., 2011).
There are several disadvantages which may accompany going public. First, the process of going public is expensive, ranging from “6% to 13% of the amount of the offering (Emery, et al., 2011). It may also be extremely time consuming. A public business must also face greater tax obligations. However, the public market can provide “a way of selling shares to get cash to pay the tax (Emery, et al., 2011).” Business owners also sacrifice a part of their ownership when they go public. Another drawback of going public is that public businesses must adhere to government regulations for shareholder reporting and insider trading. In addition, a public business may have to face shareholder demands for short-term profits which interfere with the long-run profitability and operating flexibility of the business. Finally, public shareholders may make demands for the business to pay-out dividends, even though re-investing retained earnings may be better for the business (Emery, et al., 2011).
Going Public: Reputation, management, and history
A business’s reputation, managerial skills, and operating history correlate with a business’s ability to make going public successful. If a firm has a poor reputation they will have a more difficult time establishing value in their shares with shareholders. A firm must be able to establish that it has an intelligent team able to create and follow through on a long-term strategy which shall gain the firm a competitive advantage and increase shareholder value. Operating history of the firm is important to establish that the business is profitable and able to maintain operating costs.
SNI’s Core Business and Potential
SNI’s core business is to sell and install computer networking hardware and software. SNI’s potential over the next three-to-five years seems positive. Demand has remained steady in the industry, and revenue growth has maintained a robust quality over the past five years. The growth of businesses incorporating technology into their daily functions will increase the demand for SNI’s services. However, SNI must be able to change with the technology and continue to provide its customers with the quality service they need and expect. SNI will also have to maintain its licensing with the hardware and software companies. It must also continue to hire and retain qualified and educated employees to meet consumer needs. It must maintain its competitive advantage of quality service from intelligent, helpful people. Also, concentrating on lowering the costs of goods sold and other costs will help to balance out the somewhat irregular net profit growth.
Liquidation and SNI’s Future
Liquidity will provide Simplified Networking, Incorporated with the ability to diversify its investments. In turn, this will allow it to be able to reduce the business’s total risk. Additional liquidity will also assist SNI in being able to meet transaction demands, precautionary demands, and speculative demands. Having the necessary liquidity to meet these demands provides SNI with the ability to make payments on time without incurring debt.
Gary’s personal goals include being able to maintain the role of “strategy guru” rather than spending so much time on daily functions. Gary wants to be able “to provide a return for him and his senior employees while simultaneously retaining enough funds in the firm to keep it expanding and liquid (Stretcher and Michael).” He also wants to be able to satisfy external investors in order for the business to be a success publicly. If Gary can accomplish all of these things by taking SNI public, then SNI should have a strong outlook in the future.
Investment Bankers and Objectivity
Gary has hired Jennings, who is an investment banker, to be an objective party. Jennings is acting as an intermediary between Gary and purchasers (Stretcher & Michael, 2005). However, he is also providing Gary with advice on how to issue securities for an SNI that will be to the business’s best advantage. Jennings should be trying to keep reduce SNI’s funding costs and increase investors’ after-tax-risk-adjusted return. He also assists in the underwriting and pricing of the new issues (Emery et al., 2011). Gary’s own subjectivity is not an issue for him, since he has hired Jennings to be objective for him.
SNI’s IPO Pricing
The likely IPO price for SNI’s shares would be $37.50. Based on the constant growth stock formula:
P0=D1 = 3.00 = $37.50.
The dividend is $3.00. The rate of return is .14, and the expected growth is .06. Therefore, the initial public offering of an SNI share should be $37.50.
Comparable Bonds Industry
According to Jennings, a ten-year industry bond with a $1,000 face value with a coupon rate of 8% and a coupon yield of 6% would be priced at $1,148.77. The formula is:
B0 = (40) [(1.03)20-1] + 1,000/ (1.03)20 = $1,148.77. The comparable bond’s price compared to the proposed stock IPO explicates that the stock option would be more profitable for Simplified Networking Incorporated. A 14% yield on the industry rate of stocks is preferable for SNI over the issuance of bonds at only a 6% yield.
Additional Useful Information
The case study does not provide any information about the strength of the competition within the industry. It also neglects to impart any information about the amount of market balance sheet. The case study does not include an income statement, statement of owner’s equity, or statement of cash flows. These documents are important for comprehending how SNI is managing costs and allocating its funds. These documents would be necessary for investors making important financial decisions, like whether or not they would like to invest in SNI.
Also, the case study neglects to mention how much Jennings is charging for underwriting and other fees. The case study also neglects to impart what the current IPO trends in the market are. This information would help Gary in his decision to go public. If IPO’s are not currently attracting investors it might be detrimental for SNI to attempt going public.
In conclusion, Simplified Networking Incorporated should do well going public with stock offerings. Gary has established that SNI is a good employer with intelligent employees. The business has done well at bringing in profits. The advantages of going public outweigh the disadvantages. SNI’s going public should allow Gary to meet his personal goals while increasing the liquidity of the business, and allowing it to expand while attracting external investors.