BUS 553 Module 6 Global Sources of Financing Example

Toronto, New York or Both: Raising Equity and Debt Across Borders for a Canadian Water Treatment Company

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MBA Program, Aspen University

BUS 553: Global Corporate Finance

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Month Day, Year

Toronto, New York or Both: Raising Equity and Debt Across Borders for a Canadian Water Treatment Company

ClearFlow Membranes, a composite company in Burlington, Ontario, manufactures membranes used to filter drinking water, treat industrial wastewater and desalinate seawater. Its shares trade on the Toronto Stock Exchange. Of its 410 million Canadian dollars in annual sales, about 30% are in Canada, 45% in the United States, priced in U.S. dollars, and 25% in Europe, priced in euros. It plans to build two new production lines, one in Ontario and one at its plant in the Netherlands, at a total cost of 180 million Canadian dollars. This paper compares the global sources of financing available and recommends a package.

The Financing Need

Management plans to fund about 80 million Canadian dollars with new equity and 100 million with debt, keeping its ratio of debt to operating earnings near two and a half times. The questions are where to raise the equity and in which currencies to borrow.

Equity: Toronto Alone or Cross-Listed

ClearFlow could issue shares only in Toronto, where it is well known to Canadian institutions, or it could list its shares on a U.S. exchange at the same time and offer part of the issue to U.S. investors. Many Canadian companies list in both countries, and the U.S. investor base for water technology is much larger.

Doidge et al. (2004) studied foreign firms and found that those listed on U.S. exchanges had a Tobin's q, a market-based valuation ratio, substantially higher than similar firms from the same countries that were not listed in the United States, with the largest difference for exchange listings. They attributed the premium partly to the commitment a U.S. listing makes to stronger investor protection, which limits controlling shareholders' ability to extract private benefits, and partly to better access to capital for firms with growth opportunities. Errunza and Miller (2000), studying firms that cross-listed in the United States through depositary receipts, found a significant decline in their cost of capital after listing, consistent with the idea that cross-listing reduces the segmentation of capital markets and broadens the investor base.

A U.S. listing has costs: registration, additional reporting under U.S. securities law, exposure to U.S. litigation and the expense of investor relations in two markets. For a company with ClearFlow's U.S. revenue and growth plans, those costs are likely outweighed by a broader investor base and a lower cost of equity.

Debt Options

Matching Currencies

Shapiro (2013) explains that borrowing in the currency in which a company earns revenue creates a natural hedge: if that currency weakens, both revenue and debt payments fall in the parent's currency, limiting the effect on the ability to repay. ClearFlow earns most of its revenue in U.S. dollars and euros, while much of its cost base is in Canadian dollars. Borrowing in Canadian dollars only would leave it exposed: if the U.S. dollar fell against the Canadian dollar, its U.S. revenue would shrink in Canadian terms while its Canadian dollar debt payments stayed the same. Borrowing partly in U.S. dollars and euros aligns debt service with revenue.

The Investors Each Market Reaches

Each source brings different investors. Canadian bond buyers are pension plans and insurers familiar with ClearFlow's history but limited in number. The U.S. private placement market draws large insurance companies that lend for long terms to mid-sized firms that may not have public credit ratings, and they typically hold notes to maturity, offering stable relationships. Dutch banks know the Netherlands plant and its customers and can lend against that asset. Spreading financing across these groups reduces ClearFlow's dependence on any single market, which matters in periods when one market tightens.

Disclosure and Governance After Cross-Listing

A U.S. listing would bring obligations beyond reporting. ClearFlow would need audit committee arrangements meeting U.S. standards, internal control certifications and closer attention from U.S. analysts and proxy advisers. These obligations strengthen governance, which is part of the reason markets value cross-listed firms more highly, but they require additional staff and board time.

Comparing the Costs

The euro loan carries the lowest rate, reflecting lower euro interest rates, and the U.S. dollar notes the highest. But nominal rates should not be compared directly; differences largely reflect expected currency movements and inflation. What matters is the match between the currency of the debt and the currency of the cash flows that will repay it, and the terms that come with each source.

Timing and Market Conditions

Equity issues are sensitive to timing. Water technology shares have traded at high valuations as governments fund infrastructure and industries face stricter discharge rules, which makes this a favorable moment to raise equity. Debt markets are open but rates are higher than in recent years, so ClearFlow should keep maturities long and avoid floating rates it cannot hedge.

Recommendation

ClearFlow should raise 80 million Canadian dollars of equity through a simultaneous offering in Toronto and on a U.S. exchange, accepting the costs of a U.S. listing in exchange for a broader investor base and a likely lower cost of equity. It should borrow the equivalent of about 60 million Canadian dollars through U.S. dollar private placement notes and about 40 million through the euro loan secured on the Netherlands plant, keeping its existing Canadian dollar credit line for Canadian working capital. The package matches about 60% of new debt service to U.S. revenue and 40% to European revenue.

Conclusion

ClearFlow's expansion can be financed in several markets and currencies. Evidence suggests that a U.S. cross-listing could raise its valuation and lower its cost of equity, and matching debt to the currencies it earns reduces currency risk on repayment. A package combining a dual listing, U.S. dollar notes and a euro loan uses global markets to fit the company's international business.

References

Doidge, C., Karolyi, G. A., & Stulz, R. M. (2004). Why are foreign firms listed in the U.S. worth more? Journal of Financial Economics, 71(2), 205-238. https://doi.org/10.1016/S0304-405X(03)00183-1

Errunza, V. R., & Miller, D. P. (2000). Market segmentation and the cost of the capital in international equity markets. Journal of Financial and Quantitative Analysis, 35(4), 577-600. https://doi.org/10.2307/2676256

Shapiro, A. C. (2013). Multinational financial management (10th ed.). Wiley.