All papers are checked via
|← Government Economic Policy||The Long-Run Performance of Initial Public Offerings →|
The recent IPOs that have been done by my team have contributed to the rising up of the Dubai Financial Markets. In October 2010, Axiom, which is a branch of Axiom Telecom and is partly owned by the Ruler of Dubai, Sheikh Mohammed bin Rashid Al Maktoum, sold up to 35% stake within the remaining part of the year. Actually, this was the first ever successful IPO in Dubai from the time when the global financial meltdown in 2008 had occurred. My team was the joint bookrunners for the issue in the process, and at this time the IPO was valued by a market process. In this IPO, the shares delivered a large amount of profits within the first day of trading due to the fact that the shares were valued at AED 1. However, during the first half of 2011, the Dubai Financial Market realized a poor performance in terms of the issuing of IPO. During this time, the number of floats reduced to four, in contrast to the first half of 2011 which had eight floats. In addition, the deal values also crashed down to $358 Million in contrast to $830 that was raised in the first half of 2010. My team assessed the market condition and realized that the drop in both the number of floats and deal values were attributed to the fact that many investors still feared to take part in the process because of the uncertainties in the financial market caused by the global financial crisis. As a result of this, the demand for new issues fell sharply.
My team enabled Eshraq Properties Company, which specializes on real estate business in the UAE, to raise $225 million on the Abu Dhabi Stock Exchange. Actually, Eshraq Properties attracted a wide variety of investors ranging from local investors as well as international investors. In the same half of the financial year, my team organized for another successful IPO for Saudi Integrated Telecom Company which raised about $93 million in the process. This IPO too attracted a wide variety of investors ranging from local institutional investors to foreign investors. These two IPOs in the first half of 2011 produced a long anticipated stop of the IPO drought in the UAE Stock Exchanges. The most prominent of these is the IPO by Eshraq Properties which rose from recession to raise a huge amount of money that attracted the most number of investors and changed the shape of the entire market by boosting the confidence of potential investors which had long been lost. Consequently, my team has further initiated equity offerings for the local based companies that wish to be listed on the international markets which offer many benefits. The interest from the investors will be aroused and the market demand will be boosted when growth prospects are noted by them.
My team has, therefore, managed to initiate offerings that manage to balance the needs of the currently accessible investors with the needs of the new potential investors. As a result of this balancing mechanism, all parties will be winners; thus, a good IPO creates a win-win scenario rather than favors the chosen few. My team always looks at the financial history of a company before starting the process of issuing its shares to the public. A strong financial history of a company will make it easy to attract a great variety of potential investors in addition to making a good reputation within the market place. Therefore, when my team is granted the opportunity to work on the proposed IPO, we will work on popularizing its IPO stock which will enable it to get sufficient coverage in the financial press. This is a strategic move aimed at creating new demand for the stock. As a result of this, the prices will shoot up and eventually surpass the listing price. When this is viewed from the value investor’s perspective, before listing a company, it is worthy to note whether the IPO provides enough information with regard to the financial history over a specific time frame. This will be so much beneficial towards evaluation of the stock.
The Initial Public Offering (IPO)
Initial public offering (IPO) refers to the process whereby a private company trades its stock to the community for the very first time (Aggarwal 6). In many cases, the IPO process is mainly done by smaller companies that intend to seek for capital in order to expand. However, the IPO process can as well be used by certain large companies which are privately owned and seek to become publicly traded. In the IPO process, the issuer of the IPO seeks for the help of an underwriting firm. In most cases, the underwriter normally is an investment bank that has the capacity to offer guidance on what type of security to issue and at what price and when to introduce it to the market. An IPO can prove to be a risky venture for the investors because of the fact that it is so hard to forecast how the new stock will behave on the first day of trading or in the first periods of trading because of the fact that the historical financial data that is available to analyze the company is insufficient. Many IPOs involve companies that are going through a transitory phase in their stage of growth and development; this, further brings out uncertainties regarding the future prospects of the company. IPO goes way back to 1602 when the Dutch East India Company issued its stock and bonds to the market.
Reasons for Listing the Company
A company earns money directly through listing its securities to the public for exchange. The investors pay money to purchase the lately issued shares and this money goes directly to the company. Thus, through an IPO process, the company will be in a good position to attract a wide pool of investors at the same time, hence, making it possible for them to obtain sufficient capital for the future growth of the company. In the event that a company has been listed, it has the ability to engage in a secondary offering by issuing additional common shares, hence, gaining more capital for its growth and expansion without having to face any extra debts. Many companies are motivated to issue their shares to the public because of the ability to raise adequate amount of capital from the markets within a shorter time frame (Aggarwal 7).
A company will consider an IPO when it seeks to strengthen and expand its equity base. This is very necessary for the financial growth and elevation of the company. In addition, when a company issues its shares to the public, the possibility of accessing capital becomes cheaper, faster, and easier due to the fact that many potential investors are willing to invest in the company at the same time (Chen and Ritter 15). Nonetheless, an IPO boosts the popularity, esteem, and the public image of the company; a successful IPO portrays the company as a possible hub of investment and in the process, several investors will be attracted in the company and will do all they can to be part of the success. Another important benefit of IPO is that it brings about various financing opportunities for the company; for instance, the company can get access to quick and cheaper loans from the banks, the company can also gain from its rapidly expanding equity base and also the company can use convertible debts as a way of raising the capital. In many instances, IPO fosters acquisition of smaller firms by the established larger firms; this is seen as a strategic move for expansion of the big companies. If the IPO is successful, there is a huge possibility that the company will attract and retain quite a good number of employees or management staff (Chen and Ritter 15).
However, there are various shortcomings that come about with the IPO process. Organizing an IPO is very expensive and poses a major financial challenge to the company, therefore many small companies are not able to meet this cost and they shy away from the process. Before an IPO is completed, the company is required to disclose information with regard to its financial history; many small companies find it so hard to disclose the required information due to the fact that they cannot get some of it, as a result, they are shut off from the IPO process (Michaely, Thaler, and Womack 13).
The Basic IPO Process
In an IPO process, there are underwriters involved. The underwriters are normally investment banks. The company that issues its shares in the IPO is normally referred to as the issuer; thus, the issuer engages in a contract with a top underwriter with the aim of selling its shares. The underwriter then performs the task of looking for valuable investors who are willing to buy the shares of the company. The underwriter sells the shares of the company through various methods. These methods include firm commitment contracts, bought deals, Dutch auction, All-or-none contracts, and best effort contracts (Ritter 12). When the IPO is expected to be large, a syndicate of investment banks underwrites it. This syndicate of underwriters is normally led by a lead underwriter. When the shares have been sold, the commissions for the underwriters are computed as per the total percentage of the shares sold. The total shares sold are normally referred to as the gross spread. In an event that there are many underwriters, the lead underwriter normally takes a larger portion of the commissions, usually up to 8% (Ritter 12).
The IPOs always have to involve law firms in order meet the many legal obligations that they have to meet in the IPO process. Many of these law firms have high reputations because of the fact that they have spearheaded several IPOs. The main target markets of the IPOs are the institutional investors and the retail clients of the underwriters (Ritter 12). The shares are normally sold by licensed securities sales people who receive commissions from the dealers. In the U.S., the shares can only be sold when the Securities and Exchange Commission have cleared the final prospectus of the shares. In some circumstances, the issuer of the IPO can give the underwriters the go ahead to enlarge the size of the offering by as much as 15%. This is normally called overallotment or the greenshoe option (Ritter 13).
Requirements for Listing
Listing is the process of admitting securities so that they can be traded in a recognized stock exchange. The securities that are traded can be of a company (both private and public), government securities, municipalities or other financial institutions (Chen and Ritter 12). The main driving motives for listing a company are to marshal savings to foster economic development, protect the interests of the investors by facilitating full disclosure, and to make available sufficient liquidity for the securities. Various countries all over the world have stipulated some requirements for a company to be considered for listing in the stock exchange. When a company meets these requirements, it will be eligible and approved for listing. These guidelines are necessary as they govern the issue of shares, public placements, and amalgamations.
For a company to be listed, it should have a good number of millions of dollars in terms of its tangible assets. In addition the company should exhibit a good trend of growth prospects which should be positive; this demonstrates the company’s ability to attract and retain potential investors or customers. It is also beneficial for the company to possess a strong and efficient management team who will work objectively towards meeting the financial obligations of the company; without a strong management, the financial visions of the company will be greatly compromised (Michaely, Thaler, and Womack 14). Besides those requirements, the company should have a strong organizational structure which should foster stability and further growth of the company.
The prospectus of the company is required to have all the information with regard to the requirements of the potential investors. This information takes account of the financial strengths of the company, the management team, challenges that the company is likely to experience, memorandum of the company, and the potential markets that the company is postulated to have. The prospectus, therefore, allows the investors to make informed decisions with regards to the rights and legal responsibilities that are part of the securities being offered in the IPO process. In addition, the prospectus makes it possible for a faster evaluation of the company’s financial position in terms of the profits and losses.
Due diligence, on the other hand, entails the standard of suitable disclosure or revelation, thus, the potential buyers and the relevant information that is in line with the issued security in the IPO process. A company, therefore, has a legal obligation to disclose information with regards to the, investment strategies, the financial history of the company, the available audited financial statements, the regulatory registrations, the projected value of the company, and the risks and uncertainties that the company has or is expected to have (Michaely, Thaler, and Womack 15).
Advantages of Dual Listing
A dual listed company is a structure in which two companies function as one operating company through a legal equalization agreement, but maintain separate legal identities and stock exchange listings. Dual listing enables a company to minimize the flow-back of investors. The flow-back of investors normally lowers the prices of the stock in the market. Dual listed companies always do not need to be regulated, thus, they have no constraints with regards to foreign investment requirements. In addition, the tax that the company pays will be considerably reduced due to the fact that there are two companies that function as one entity (Aggarwal 8).
The Percentage of Shares to be offered in the IPO
There are various factors that can determine the amount of shares to be offered in the IPO or the amount of shares to be retained by the company. The main determinant is the aspiration to raise a given amount of money in the IPO process with the aim of fostering the growth prospects of the company. In addition the level of the demand by the investors also plays an important role in determining the amount of shares to offer in the IPO process. Another important factor is the opportunity that is presented in the market and the capital needs of the company; for instance an airline corporation is more likely to issue more shares than a computer company (Ritter 15).
My team usually advises companies or corporations to approve at least 15 million to 20 million shares of their common stock. In this case, around 12 million or 14 million shares should be issued to founders who have 3 million to 4 million share option collection; this gives rise to a well diluted base of at least 12 million shares. The remaining shares that are already authorized but are yet to be issued, serve as a reserve in the event that more shares are still required to be issued in the market.
Scrutinizing this from a mathematical concept, there is really no concern whether the company has 3 million or 12 million shares that are fully-diluted. In essence, if in any way the company decides to award options to new employees, it will be better to receive the options so as to buy 120,000 shares in contrast to 12,000 shares, regardless of the fact that this might be a representative of a similar percentage ownership of the company.
Supposing that the IPO has a price of $25 per share and is fully-diluted because of earnings, and in addition it has about 40 million shares that are outstanding; this will result to $1 billion market capital, which is actually more than the minimum market capital size that is a requirement of a successful IPO process. With regards to this, the company has no need of making reserves during the IPO process.
My team recommends the book building process for the valuation of the IPO. Book building entails the process whereby the demand for the investors is created, captured, and documented with the aim of determining the efficient price (Michaely, Thaler, and Womack 20). In many cases, the issuer of the IPO recommends a leading investment bank to play the role of a book runner or the underwriter. In the book build process, the transfer of shares is off market, hence, not guaranteed by the clearing house. The underwriter is faced with the responsibility of bearing the risk of an acquirer failing to pay or the seller failing to deliver.
Book building is gaining popularity in the current global markets due to the fact that it is very common in many developed countries. In the book building process, the bids of the IPO are mostly done online while the underwriter maintains the book off-market and keeps the bids confidential (Michaely, Thaler, and Womack 20). When the book has already been closed, the book runner consults with the issuer in order to determine the price at which the new shares should be sold. Mainly, only the clients of the book runner are invited to bid. If all the investors are to be offered the issue, then more disclosure is required by the securities law. Only a certain class of investors is allowed to participate in the book build process. The bidding process is mainly done through invitation but in some cases, the issuer and the book runner or the underwriter have the privilege of allocating a large number of bids to certain investors as opposed to others. Actually, it is common that the bidders from large institutions have much more preferences to the small retail bidders in terms of the allocation of bids in the IPO process. During the book building process, the bidding is normally conducted off-market as a result of the rules of the stock exchange that call for the stopping of on-market trading.
The biggest distinguishing factor between trading off-market and trading on-market is that in the off-market mode, the bids into the book are kept confidential as opposed to the on-market mode where the bids and the asking prices in the stock exchange are expected to be transparent (Ritter 23). In addition, the off-market mode calls for the bidding to be done by strictly invitation as opposed to the on-market mode where any investor is invited to bid. In the off-market mode, all the traded shares have the same price as opposed to the on-market mode whereby multiple prices exist for the shares in the market.
Book building takes a process whereby there is a given fixed period of time when subscription is left open; during this period, the book runner has the duty of gathering bids from various potential investors at various prices. The bidders have the option of revising the bids before the closure of the book by the book runner. The book building process targets both the large institutional investors and the retail investors. When the book has already been closed, the final issue price is determined and the book runner has another duty of weighing up all the bids collected with the aim of setting the final price of issue. The book can be oversubscribed in case whereby the demand for the securities rises and in the event, the greenshoe option is set off (Chen and Ritter 16).
Book building, therefore, is a process that can be used by companies either when they are raising capital through IPOs or when they are following up on the public offers (FPOs). The main motive for book building is to help in discovering the price of the shares or the demand of the securities. The issuer sets up the price at which the securities are issued while the book runner collects the bids from various investors at different prices. The demand for the shares or securities will at the end determine the price of issue; this is always after the closure of the bidding process (Aggarwal 21). My bank is expected to be the lead underwriter and the compensation that my team will get will come from the gross spread, that is, the difference between the price of the securities bought from the issuer and the price at which the investors pay for it. As the lead underwriter, my bank is expected to get a fee of 20% of the gross spread.
Finance and Marketing of the IPO
The marketing of the IPO always commences after the registration statement has been approved by the SEC. In many instances, a Red Herring is sent to the relevant sales force and the potential investors all over the country. Consequently, the company together with the underwriter engages in road shows in order to promote the IPO. The road shows are beneficial to the company because of the fact that there is increased interaction between the company and the investors, thus, the company uses that opportunity to make presentations with the aim of promoting the securities to the institutional investors (Aggarwal 11). Generally, a road show is expected to last for around three to four weeks and in each day, there are at least two meetings with both the sales people and the potential institutional investors.
The IPO road show will take the form of a sequence of meetings from corner to corner across different cities whereby the top management of the company will finally have the chance to talk to the existing investors as well as the potential investors. The main notion of conducting a road show is to sell the company to the investors. The top management of the company should speak the sales language which will entice the potential investors to buy the securities of the company. In addition the top management of the company should be consistent with their goals and motives of securing a strong financial position for the company. Before setting up a road show, both the underwriter and the company are expected to draw up a plan that is achievable. This plan is expected to guide and control the activities that entail a road show. The kind of road show to be put up will be greatly influenced by the number of shares that are expected to be issued in the IPO process.
During the progress of the road show, many investors will greatly express their interest on the securities and give their feedback to the underwriter. There are several differences between the interests showed by the retail investors and the interests showed by the institutional investors. The institutional investors always give in limit orders, whereby, the total number of securities demanded is subject to their maximum price; on the other hand, the retail investors give in a market order which only shows the total number of shares needed by them. In addition, the retail investors always submit their orders in the early stags of the road shows, whereas the institutional investors always have a preference of waiting until the last stages before submitting their orders.
Road shows have all along proved to be an efficient way of marketing the securities and without them very many investors are kept in the dark with regard to the shares that are to be issued in the market. Road shows involve additional costs, both which the company and the underwriter are expected to meet. A well organized road show will yield more results with regard to capturing and retaining many investors, thus, the company and the underwriter should mainly concentrate on the markets that have many institutional investors. This is intended to help in maximizing the number of securities that are expected to be sold (Aggarwal 11).
The information regarding the final issue price or the discount that the dealers are expected to receive, cannot be included in the marketing process due to the fact that the marketing process takes a long period. The underwriter files an acceleration request with the aim of requesting the SEC to speed up the date upon which the registration should be completed. The issuer also has a say on the date upon which the registration process should be completed because of the fact that he or she participates in assessing the conditions of the market.
On the eve of the date of issue after the market has closed, the company will meet the lead underwriter with the aim of sorting out some important details regarding the IPO process. One of the details pertains to the offer price and the other detail pertains to the total number of shares that will be issued. When the pricing is being determined, the institutional investors and the retail investors whose details have been recorded in the order book will be given first hand attention. In order to create a good and successful IPO, the offer should be oversubscribed by at least two to three times. When the IPO is underpriced, both the retain investors and the institutional investors expect the issue price to rise within the day of offer; this is a positive note as it increases the demand for the issue. With regard to the company, under pricing of the shares limits the company from realizing the full value of its shares; however, if the under priced issue succeeds, it will be to the company’s advantage ((Michaely, Thaler, and Womack 15).
The Underwriting Agreement will be launched as soon as the final terms have been settled. At this time, the underwriter will file a price amendment after the final prospectus has been printed out. After the IPO has been brought to the market, other activities that will still be required to be tackled by the underwriter include post-market stabilization, recommendation by analysts and establishment of the market in stock. The underwriter is expected to buy shares, in case imbalances occur in the process; this aims to foster stabilization (Michaely, Thaler, and Womack 15).
The final process of the IPO always occurs after 25 days when the IPO has been launched. This is always the period when the quiet period stage of the IPO comes to an end. During this stage, the underwriters have the chance of giving comments with regards to the valuation of the company as well as estimating the earnings that the company is projected to make (Ritter 21).
The initial public offering is a long process that entails a series of tasks by the issuing company, the lead underwriter, and the syndicate members. The expertise of the underwriter plays a huge role in shaping the IPO process, thus, the company really counts on this. The underwriter is expected to solicit for markets, establish the price of issue, distribute the issue, stabilize the market of the shares, and offer support to the issue. At the same time, the underwriter will really count on the information that is provided by the company and the honesty of the company with regards to the provision of the information. The potential investors who are mainly the public are given a new avenue for making investments.
My team has succeeded in spearheading many successful IPOs and this one will be just a ‘walk in the park’ for my team. My team can guarantee the company much success in the IPO process due to the fact that we have a wide range of experience in terms of spearheading many IPOs in the recent past. So long as the company gives us the relevant information that we need and the relevant time period that is essential, much capital will be generated by attracting as many investors as possible and also by setting up an efficient price.