Investment Economics and Valuation Prof.

Wilfred Manuela
KAT Chua, CJ Pimentel, EDWARD Solicito October 1, 2017
Learning Team 3 MIB 2017
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Written Analysis of the Case:

Affymax, N.V. : An Initial Offering

The Case:
It was July of 1991 when Dr. Alejandro Zaffaroni, chairman of the board and founder of
Affymax N.V. (Affymax), along with the companys senior managers decided that it was time
for the company to go public. Since the companys inception in 1989, Affymax was able to raise
USD 60 million without any help from venture capitalists or investment banks. This magnificent
feat was attributed mostly to Dr. Zaffaroni and his reputation as an institution in the biotech
industry. That being said, doing an Initial Public Offering (IPO) is a whole different challenge.

The decision to have an IPO was made out of necessity. During the past few years,
Affymaxs revenues were dismal and the whole company was suffering from losses. To be able
to survive, be more flexible and continue its operations, additional capital is badly needed. Given
how crucial the IPO is for the company, it is important to have a thorough analysis of Affymaxs
current situation, a review on how the investment banker was selected, an evaluation of the risks
of underpricing and overpricing, as well as finding out what is the optimum price.

Case Facts and Assumptions:

The company is 34 months old.
Affymax legal home is in Europe, while its research headquarters was in Palo Alto,
California.
Affymax had USD 35 million in cash on hand at the time of the IPO.
A tentative offer of USD 17 to USD 20 per share had been determined during the date of
the preliminary prospectus.
Affymax sold 15 percent more shares than planned in the offering as over-allotment.
The company would be listed on the NASDAQ index, under the symbol: AFMXF.
There are three components of the spread: the Management Fee (20%), Underwriting Fee
(20%) and Selling Fee (60%).

Investment Banker Criteria

(Review how the lead investment banker was selected. What other criteria not mentioned
in the case might be important)
 As part of the preparations for the IPO, Affymax went to find investment banks that
would compete to underwrite the issue. Because of the huge potential of both Affymax and the
Biotech industry as a whole, the company was not surprised that there were 15 banks that
expressed their interests in the IPO.

After a long and difficult selection process, Goldman Sachs was chosen based on three
primary investment banker criteria: understanding of Affymaxs unique position due to the
reputation of individuals involved and the technology, international distribution capability and a
well-regarded biotech investment research analyst.

Goldman Sachs is the leading global investment banking, securities and investment
management firm that provides a wide range of financial services to a substantial and diversified
client base that includes corporations, financial institutions, governments and individuals. This
characteristic satisfies Affymaxs requirement of an investment bank having an international
banking capability.

Goldman Sachs ability to understand Affymaxs unique position and its well-regarded
biotech investment research analyst is also very important but its technicalities and details was
not disclosed in full. (According to the case, one of the reasons why Affymax argued for Alex
Brown and Sons to be a co-manager was because of its significant contact with biotech investors
and their widely followed research analysts, suggesting that Goldman Sachs might not be
sufficient). That being said, if Goldman Sachs were able to satisfy both of these requirements, it
would also reflect their eagerness and their commitment to this activity.

Aside from the three criterias stated above, there are others that should be deemed
important and should be considered. Examples of such are: the investment bankers brand, its
history with company IPOs and the satisfaction level of its existing clients.

An established investment bankers brand is very much beneficial for Affymaxs IPO.
Investors would have an increased confidence in the potential of the Affymax stock because of
the underwriters well-known and tested competence and quality. This ultimately increases the
companys value, as it seems to become a low-risk, high-reward venture. Given the brand of
Goldman as an investment bankers brand, this also assures Affymax of a wide variety of
networks, creating better avenues for advisory firms on efficiently evaluating and marketing the
company.

It is also a huge advantage for an investment bank, especially during a selection like this
one, if it has a strong history with regards to company IPOs. Because an IPO is very crucial for
any company, having an underwriter who can guide them on the best practices used for this
activity would almost be invaluable for them; in this case for Affymax. The history of the
relationship also dictates the level of intimacy, involvement and engagement that the investment
bank will have when making decisions with the company. This is important because having a
relationship such as this with the companys partners will showcase the level of comfortability
that the stakeholders will have with the bank.

Lastly, research can be done to check if Goldman Sachs currently existing and past
clients are and were happy with the services that they commissioned. This information would
describe the quality of their service and how they interact with their clients. Knowing the
existing and past clients that the investment bank had will allow Affymax to see the potential
conflicts that may come up when scheduling meetings with the investment bank, and the fee
structure of the bank.

Revenue Earnings
(What was the amount of revenue the investment bankers could expect to earn if the final
amount was approximately USD 80 million?)

The initial amount of shares that Affymax was willing to offer was 4 million shares at
$17 - $20 per share. However, they also made a deal with the investment banks to issue up to
15% more shares (600,000) in order to protect them from short selling. The price per share and
the number of shares may fluctuate, but we can assume that the total value for all the issued
shares amounted to $80 million.

According to Chen and Ritter (H. C. Chen and J. R. Ritter, The Seven Percent Solution,
Journal of Finance 55 (June 2000), pp. 11051132.), for almost all $20 - $80 million sized IPOs,
the general spread was 7%. If we were to follow this rule with regard to Affymax, investment
bankers could expect to earn $5.6 million USD from the $80 million revenue for just selling the
shares at 7% spread. They can expect to earn more fixed fees from the services that they provide
as underwriters and analysts for Affymax.

Underpricing and Overpricing

(What were the risks to the firm and the investment bank of an underpricing? Of an
overpricing? Which is worst?)

Underpricing stock will allow new entrants and investors to buy into your company, and
this causes a problem with issuance of additional stock. Underpricing stock, therefore, causes
opportunity cost, since the offering price was less than the true value of the issued securities,
investors who got the issue would get a bargain at the expense of the original shareholders of the
firm. However, this is balanced out with the effect of a higher demand for the stock and the
revelation to the original shareholders that the issues they have may have a higher market
valuation than thought at first.

Overpricing stock may cause you to issue stock to invest in a project that gives out a
lower rate of return, and pinning it against your stock may cause you to gain a negative value in
the net present value. A high price in stock may cause the company to see less attractive to
investors. Overpricing is often caused by overhyping or bias of the founders, venture capitalists
and underwriters. Majority of overpriced companies lie within the medium-to-small or immature
companies, since they are barely covered by financial analysts. This is due to the fact that these
types of companies are often the bearers of short history, thus making it difficult to assess the
companys performance.

That said, overpricing stock is generally the worse option as it can reduce demand for the
stock and leave the company with unsold and unwanted stock. In addition, if a stock was
overpriced and introduce into the market, it would eventually lower in value and even out which
can turn off future investors and sources of funding as opposed to underpricing it and seeing the
price rise, which can attract investors. Having a company push through at an underpriced value,
it would still attract investors to put money in the company due to the low-cost opportunity of
investment, whereas an overpriced stock would immediately turn off investors, and risk having
zero-investment from the market.

Good and Fair

(How could a good and fair price be judged?)

The best way to price a stock is to base it on a companys track record and historical data,
the key metrics being EBITDA, ROA, Dupont, and more. Valuation methods such as the
discounted cash flow analysis are also solid ways of fairly judging a stocks price. The overall
value of a company can be justified as good and fair, if we are to look at the intrinsic value of the
company, which is minimally dependent on the future forecast of returns, but on the financial
data that a company has. That being said, the best way to value a company is through discounted
cash flows as it pertains to assumptions of the businesss worth in order to generate cash as a
reflection of initial cost of capital. Another means to value the company is through current net
equity added by the overall total earnings that is above the required return on equity (which is
dependent on market price and security yields).

Unfortunately, Affymax is a company with little to show for performance, with the
majority being losses anyway. However, though risky, it is still highly valued for its potential to
grow due to its innovative methods that affect the biomedical industry. This makes the company
a bit more difficult to valuate than that of others, due to the lack of financial information for
market projection.

For Affymax, one way to price its stock is to look at the demand for its shares. The road
show that the underwriters assembled revealed that potential investors were willing to buy up to
20 millions shares in the company. This is extremely positive for Affymaxs valuation and
should be taken into consideration when judging a fair price.

The last method is to look at similar companies in the industry, checking for the market
multiple. The market multiple takes into account the markets willingness to pay for stocks of
similar companies within the same industry or that have similar products or services. For
Affymaxs competitors and counterparts, it can be seen that a lot of them offered shares at a
higher price than filed in their prospectus. This is an indicator that Affymax should value its
company a bit higher than $17-$20 per share as the industry norm is to offer it a bit higher.
Although since Affymax has an earlier stage of development, and is still initially riskier, the
price can therefore be increased later on is a possibility.

Recommendations
(What price and spread would you recommend?)

The recommended spread for this IPO is 7% as it is what most USD 20 - USD 80 million
IPOs generally fall into. For the price, several iterations were made based on the filed price as
well as the industry deviations based on offered price, current price, and 52 week high.

Table 1. Affymax Share Prices

However, it should be noted that the 20 million shares demand from potential investors in
the road show should increase the price that the shares would sell. Finally, other qualitative
factors such as Dr. Zaffaronis reputation for success as well as the potential profits from the
technology that Affymax offers should increase the offered price per share.
The 20 Dollar Price
(Refer to Exhibit 5. If a sale price to the public of USD 20 per share were chosen, how could
this be justified using a dividend discount model and the research analyst's projection in
Exhibit 5?)

While the dividend discount model is a very good way to value and justify choices made
regarding share pricing, it is extremely difficult to apply in this sense as the growth rate is very
volatile and erratic. Furthermore, it is assumed that the dividends per share is the same as the
earnings per share in this case.

Based on research, the usual cost of capital for early stage bio-tech ventures should be
20% or higher. Though it is already well on its way in the IPO process, its operations, assets,
and losses still suggest that it falls into this category. Assuming 2002s earnings per share will
remain constant throughout the following years, the present value for a share should be $23.88.

Table 2. Affymax Earnings

This shows that a $20 price per share offering is not only justified, it is actually
underpriced. To add to that, this does not include the demand from the road show as well as the
potential profits from new innovations that Affymax may produce.