Initial public offering as a growing trend

[Atila]

March 14th, 2007

Initial public offering as a growing trend

Though not an entirely new concept, IPOs have in recent times become very popular and have greatly advanced public awareness of capital market activities in the country, writes Chinedu Dike
Over the years there have been concerns regarding the depth and capacity of the Nigerian capital market to absorb heavy offers. The initial public offerrings (IPOs) of heavy weights like Dangote Sugar Refinery plc and Transnational Corporation of Nigeria (Transcorp) plc may have just provided the test cases to confirm the much desired depth and capacity of the market.

Dangote Refinery between November 15, and December 22, 2006 made an IPO to raise N54 billion from the market through the issue of 3.0 billion ordinary shares of 50 kobo each at N18 per share. The offer was 300 per cent subscribed.

Also Transcorp made an IPO to raise N60 billion through the issue of 8.0 billion ordinary shares of 50 kobo each at N7.5 per share. The offer opened December 27, 2006 and closed January 31, 2007. The result of the offer is still awaited, but market expectation is that it will be oversubscribed.

As the government prosecutes the privatisation, is expected that other heavy IPOs from the power, oil and gas sectors will hit the market and provide needed depth.

The financial sector reforms and particularly the consolidation programme of the banking sub-sector came with it a series of IPOs. The reason for this is not far-fetched. Prior to the consolidation, most of the banks in Nigeria were privately owned and their shares were not available for transaction at the stock market. Trailing on the success of the banks, other companies in other sectors also accessed the market either by way of IPO, rights issue, public offering or offer for subscription.

The exercise, apparently because of the way it was prosecuted, also raised public awareness not only on IPOs but also on stock market investments. And the result is that there are presently more participants in the Nigerian capital market than ever before. Also the market has witnessed tremendous growth in the last few years.


What is an IPO

Initial public offering (IPO) is the first sale of stock by a private company to the public. IPOs are often issued by smaller, younger companies seeking capital for expansion. It can also be done by large privately-owned companies looking to having their shares publicly traded at the stock market.

In an IPO, the issuer obtains the assistance of an underwriting firm, which helps it determine what type of security to issue (common or preferred), best offering price and time to bring it to market.

IPOs can be a risky investment. For the individual investor, it is tough to predict what the stock will do on its initial day of trading and in the near future since there is often little historical data with which to analyze the company. Also, most IPOs are of companies going through a transitory growth period, and they are therefore subject to additional uncertainty regarding their future value.

According to a senior executive in Afribank, "I have refrained from participating in IPOs, and up till now am not contemplating doing that either." His argument is that most of the IPOs are hastily packaged and there is not adequate information that would give strong support to the confidence of the investor. "I feel safer going into the stock after allowing sometime for some of the elements of the offer prospectus to chrystallise.

However some IPOs have proved to be worthwhile investments. This is because the tendency for immediate and short term rapid price gain, which follows the listing of the new shares on the Exchange have provided opportunities for capital gains for the investors.

Although, ,,,,,,,, a leading stock broker have condemned the attitude of some issuing houses to manipulate the prices of companies that went through IPO upon listing to achieve price rise even the firm’s fundamentals does not justify that. Beyond this manipulations, IPO firms have turned out to do better than when they were still private firms.


Transformation phases of an IPO

While some large and successful companies are still privately-owned, many companies aspire toward becoming a publicly-owned company with the intent to gain another source of raising funds for operations. An IPO represents a private company’s first offering of its equity to public investors. This process is generally considered to be very intensive with many regulatory hurdles to jump over. While the formal process to produce the IPO is well documented and as a result is a fairly well-structured process, the transformational process of which a company changes from a private to a public firm is a much more difficult process.

Henry Lariyetan, vice president, BGL Securities, a leading investment company, a company goes through a three-part IPO transformation process: a pre-IPO transformation phase, an IPO transaction phase and a post-IPO transaction phase.

"The pre-IPO transformation phase can be considered to be a restructuring phase where a company starts the groundwork toward becoming a publicly-traded company. For example, since the main focus of public companies is to maximize shareholder value, the company should acquire management that has experience in doing so. Furthermore, companies should re-examine their organizational processes and policies and make necessary changes to enhance the company’s corporate governance and transparency. Most importantly, the company needs to develop an effective growth and business strategy that can persuade potential investors the company is profitable and can become even more profitable. On average, this phase usually takes around two years to complete."

The IPO transaction phase usually takes place right before the shares are sold and involves achieving goals that would enhance the optimal initial valuation of the firm. The key issue with this step is to maximize investor confidence and credibility to ensure that the issue will be successful.

For example, companies can choose to have reputable accounting and law firms handle the formal paperwork associated with the filing. The intent of these actions is to prove to potential investors that the company is willing to spend a little extra in order to have the IPO handled promptly and correctly.

The post-IPO transaction phase involves the execution of the promises and business strategies the company committed to in the preceding stages. The companies should not strive to meet expectations, but rather, beat their expectations. Companies that frequently beat earnings estimates or guidance are usually financially rewarded for their efforts. This phase is typically a very long phase, because this is the point in time where companies have to go and prove to the market that they are a strong performer that will last.

The IPO process begins with contacting an investment bank and making certain decisions, such as the number and price of the shares that will be issued. Investment banks take on the task of underwriting, or becoming owners of the shares and assuming legal responsibility for them. The goal of the underwriter is to sell the shares to the public for more than what was paid to the original owners of the company.


Going public does have positive and negative effects, which companies must consider

Advantages

- Strengthens capital base, makes acquisitions easier, diversifies ownership, and increases prestige. Going public helps companies raise cash, and usually a lot of it. Being publicly traded also opens many financial doors:

• Because of the increased scrutiny, public companies can usually get better rates when they issue debt.

• As long as there is market demand, a public company can always issue more stock. Thus, mergers and acquisitions are easier to do because stock can be issued as part of the deal.

• Trading in the open markets means liquidity. This makes it possible to implement things like employee stock ownership plans, which help to attract top talent.

Being on a major stock exchange carries a considerable amount of prestige. In the past, only private companies with strong fundamentals reasonable track record of performance could qualify for an IPO and it wasn’t easy to get listed.

Small companies looking to further the growth of their company often use an IPO as a way to generate the capital needed to expand.

The financial benefit in the form of raising capital is the most distinct advantage. Capital can be used to fund research and development, fund capital expenditure or even used to pay off existing debt. Another advantage is an increased public awareness of the company because IPOs often generate publicity by making their products known to a new group of potential customers.

Subsequently this may lead to an increase in market share for the company. An IPO also may be used by founding individuals as an exit strategy. Many venture capitalists have used IPOs to cash in on successful companies that they helped start-up.

Disadvantages

- Even with the benefits of an IPO, public companies often face many new challenges as well. One of the most important changes is the need for added disclosure for investors. Public companies are regulated by the Securities Exchange (SEC) in regard to periodic financial reporting, which may be difficult for newer public companies. They must also meet other rules and regulations that are monitored by the Commission. More importantly, especially for smaller companies, is the cost of complying with regulatory requirements can be very high. Some of the additional costs include the generation of financial reporting documents, audit fees, investor relation departments and accounting oversight committees.

Public companies also are faced with the added pressure of the market which may cause them to focus more on short-term results rather than long-term growth. The actions of the company’s management also become increasingly scrutinized as investors constantly look for rising profits. This may lead management to perform somewhat question-able practices in order to boost earnings.


Before deciding whether or not to go public, companies must evaluate all of the potential advantages and disadvantages that will arise. This usually will happen during the underwriting process as the company works with an investment bank or issuing house to weigh the pros and cons of a public offering and determine if it is in the best interest of the company.

It puts pressure on short-term growth, increases costs, imposes more restrictions on management and on trading, forces disclosure to the public, and makes former business owners lose control of decision making.

For some entrepreneurs, taking a company public is the ultimate dream and mark of success, usually because there is a large payout. However, before an IPO can even be discussed, a company must meet requirements laid out by the underwriters. Here are some characteristics that may qualify a company for an IPO:

In packaging an IPO the Issuing House first of all looks at the salability of the of the offer using such characteristics as the issuer’s (the company’s) high growth prospects, innovative product or service, competitive strength in the industry, as well as its ability to meet financial and audit requirements.