Minicase:

Novo Industri A/S (Novo)

A case study of how a small Danish

company escaped a small segmented
capital market and internationalized the
cost and availability of capital

Novo, Current Status

Novo is a Danish multinational firm which
produces industrial enzymes and pharmaceuticals
(mostly insulin).
In 1977, Novos management decided to
internationalize its capital structure and sources
of funds.
As Novo is a technology leader in its specialties,
planned capital investments plant and R&D could
not be postponed until internal financing from
cash flow became available.

Novo, Challenges
Internalization plan was based on the observation
that the Danish securities market was both
illiquid and segmented from other capital
markets (at the time).
Management realized that the companys
projected growth opportunities required raising
long-term capital beyond what could be raised
in the domestic market alone.
In particular, the lack of availability and high cost
of equity capital in Denmark resulted in Novo
having a higher cost of capital than its main
multinational competitors.
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Novo, Challenges
Although Novos management wished to escape
from the shackles of Denmarks segmented and
illiquid capital market, many barriers had to be
overcome.
These barriers included closing the information gap
between the capital markets and the company itself
and executing a share offering in the US (which required
resolving additional barriers imposed by the government
of Denmark on securities issuances).

Novo Industri: Case Questions

1.

Why did Novo believe that its cost of capital was

too high compared to its competitors? Why did
Novos relatively high cost of capital create a
competitive disadvantage?
Novo observed that its price/earnings ratio was only
5 compared to 10 and higher for its competitors.
Novo was also told by its bankers that they could
not borrow much more and the domestic equity
market was saturated with respect to Novos stock.
Novos high cost and low availability of capital in
Denmark would prevent it from fully exploiting its
competitive advantage in research on insulin and
industrial enzymes.
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Novo Industri: Case Questions

2. Novo believed that the Danish capital market
was segmented from world capital markets.
Explain the six characteristics of the Danish
equity market that were responsible for its
segmentation.

1) asymmetric information base of Danish and

foreign investors,
2) taxation,
3) alternative sets of feasible portfolios,
4) financial risk,
5) foreign exchange risk, and
6) political risk.
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Novo Industri: Case Questions

3. What was Novos strategy to
internationalize its cost of capital?

Novos strategy was to increase its level and the

quality of its financial and technical disclosure in
both Danish and English in order to attract
foreign portfolio investors.
Sold a $20 million convertible Eurobond issue in
1978
Listed its shares on the London Stock Exchange
Prepared a prospectus for SEC registration of a
U.S. share offering and eventual listing on the
New York Stock Exchange.
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Novo Industri: Case Questions

4. What is the evidence that Novos
strategy succeeded?

Between April 1980, when its disclosure was

being maximized, and December 1986 Novos
stock price increased from Dkr2000 per share to
Dkr600 per share.
Novos P/E ratio increased from 5 to 16, which
was then in line with its competitors.
Foreign ownership had increased to over 50% of
Novos shares outstanding.

Novo Industri: Outcome

During most of 1981 and the years thereafter
Novos share price was driven by
international portfolio investors transacting on
the New York, London, and Copenhagen stock
exchanges.
This reduced Novos weighted average cost of
capital and lowered its marginal cost of capital.
Novos systematic risk was reduced from its
previous level, which was determined by nondiversified (internationally) Danish institutional
investors and the Novo Foundation.
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Novo Industri: Outcome

However, its appropriate debt ratio level was also
reduced to match the standards expected by
international portfolio investors trading in the U.S.,
U.K., and other important markets.
In essence, the U.S. dollar became Novos
functional currency when being evaluated by
international investors.

Functional currency: The dominant currency used by a

multinational firm in its day-to-day operation.

Theoretically, its revised weighted average cost of

capital should have become a new reference
hurdle rate when evaluating new capital
investments in Denmark or abroad.

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Novos B-Share Prices Compared with

Stock Market Indices

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