The excess liquidity conditions prevailing in the region’s stock markets, with Shuaa Capital index for Arab stock markets surging 80 percent so far this year on top of the 64 percent increase recorded in 2004 and 56 percent in 2003, encouraged several listed companies, especially those enjoying historically high valuations to secure large amount of new equity funding through rights issues. Several private companies attempted to raise equity through initial public offerings in the various stock markets of the region.
To date, initial public offerings (IPOs) in the region have generated around $4 billion in new funds, but that’s only half the story. Over $7 billion has already been pumped into the capital markets through rights issues alone. The trend is likely to continue especially with the new listing expected in the coming few months on the Dubai International Financial Exchange (DIFX). There are several companies capitalized at $500 million to $1 billion who have already started the process to list on the DIFX expected to be up and running late this month.
Private companies and family businesses are opening up to the prospects of a public listing. Many of them are opting to convert from limited partnership companies to private shareholding companies in preparation to going public. Increasingly more private companies are abiding by more stringent requirements of disclosure and transparency which make it easier for them to go public in the future. IPOs have become a feasible option for family owned businesses who want to realize the value of their companies, either partly or fully, or to raise additional capital.
Instead of having 100 percent ownership, companies listed on the region’s stock exchanges will be able to share the risk with other smaller investors, without necessarily losing the identity of the firm. They will also get the benefit of enhancing the company’s corporate image and public recognition in the country and the market place. The additional capital raised will allow the firm to expand while maintaining the “optimal” financial structure in terms of debt to equity ratio.
Local investment banking firms, play an important role in the IPO process. They bring to the table a wealth of knowledge and experience of the domestic economy, the local stock market, the potential investment community and above all ability to evaluate the company and come up with the “right” price and offer size of the IPO. They are also expected to devise a timetable for the process and the requirements needed by the regulatory authorities.
The investment banking firm will complete the due diligence process, which includes valuation, preparation of all the required disclosures, and a price range for floated shares. It will also devise concrete guidelines for notifying the public, for launching the offer, and for registering it with respective exchange commission or stock market authority. The process usually requires the submission of an application letter to the controller of companies accompanied by a prospectus which contains detailed information on financial, commercial, technical and legal issues, including the company’s business plan on which the valuation and the price per share will be based.
The investment banking firm will also be called upon to help in marketing the flotation by preparing the information memorandum and present it to potential investors. The marketing campaign may also include “road shows” to institutional buyers. The process of going public through an IPO will be completed once the shares are fully allocated and properly filed with the stock exchange.
Potential investors will look at the historical record of the company whose shares are being floated to make an assessment of how its business might develop. They will be most encouraged by a trend over several years of rising profitability. If the business does not have such a history, it may still be suitable for a public offering, but the range of investors may be more limited. The company going public will also want to think carefully about the ways in which to explain any problems it may have in its track record.
For a start-up company wishing to issue shares to the public, the presence of an experienced management team and a strong group of founding members are important ingredients that investors look for. As market conditions are always changing; the company needs professional advice on when to go public. In a rising stock market fueled by excess liquidity, new IPOs have a better chance to succeed. “Hot issues” characterized by oversubscription tend to surge when the floated shares start trading on the exchange. Timing of a new IPO is therefore crucial.
Another key ingredient to the success of an IPO is a well crafted and documented business plan that allows investors to assess the company’s current situation and its future potential. Such a plan would include information covering the company’s management structure, history of operation, description of products or services provided and historical financial statements for the last three years. This would lay the ground to come up with financial projections for the next five years, showing the market for the company’s product and how the proceeds of the public floatation will be used to finance expansion and do so at a profit.
Going public is a major challenge for any company. A successful IPO can greatly increase the prestige of a business, and provide the funds to satisfy the plans of the management team. However such an offering may not be suitable for all companies and certainly needs careful thought and planning before detailed work on a flotation begins. Experienced and credible investment bankers can help highlight these issues at an early stage saving both time and money. As it is the case in other capital markets, exchange commissions and stock market authorities in the region should make it mandatory for companies aspiring to go public to employ the services of investment banking firms in order to advise on the flotation process, and to prepare proper valuation and documentation. Another factor that bodes well for the future of the IPO markets in the region are the changes being made in the regulatory environment with respect to new issues. In the UAE, the Ministry of Economy and Planning placed a ban on IPOs of start-ups until a new companies law is put in place later this year. Adjustments to the company law include a proposal to limit IPOs to companies that have been operating for two-to-three years, a decision that is widely supported by many in the investment banking community.
To conclude, we believe the strong performance of the Arab stock markets last year and so far this year boosted investors’ confidence in these markets and increased their appetite for listed shares including new issues. Investment banks that have the expertise needed to evaluate companies, prepare prospectuses and successfully execute an IPO transaction are currently in place. Private companies are looking for new sources of capital to help them expand and reduce the debt/equity ratios in their balance sheet. All this suggests that the region’s stock markets should warm up to new IPOs in the months ahead, which will help absorb at least part of the prevailing excess liquidity.
(Henry T. Azzam is founder & CEO of Amwal Invest.)