A closer look at IPO
Category: Business in Great Britain
Companies and their shareholders consider publicly offering their equity in the form of shares to third-party investors — by means of an Initial Public Offering (IPO) — for a variety of reasons:
▼ Financing Growth. Many of the companies considering an IPO have reached a stage where they have strong expansion opportunities but are constrained by existing financing channels — debt capacity has been reached, or the finance on offer is inadequate or expensive (i.e. private equity funds). An IPO can enable companies to take advantage of these opportunities quickly as opposed to waiting to finance expansion through organic growth. In cases where a company has expensive debt, IPO proceeds may also be used for refinancing as well.
▼ Providing an exit for existing shareholders. There is no formal limit on the proportion of such ‘secondary’ shares that can be sold in an IPO. Shareholders will need however to take into account investors’ preference for providing capital for growth and the negative marketing signal that is conveyed in an IPO if founding or other major shareholders are seen heading for the exit.
▼ Crystallising the value of the company. An IPO provides a supply of publicly traded securities that can be used as acquisition currency and to incentivise management via option schemes.
▼ Signalling the maturity of the company. An IPO sends strong signals to the market, competitors, and the issuer’s various stakeholders that the company has come of age in terms, variously, of its market position, corporate governance and disclosure practices. This motivation is particularly apparent when the issuer chooses to list on one of the leading international stock exchanges, such as the New York or London Stock Exchanges (NYSE & LSE) or NASDAQ.
▼ Acquiring prestigious international institutional investors as shareholders. These investors tend to hold their positions for a reasonable length of time rather than indulge in short-term speculative behaviour. They can also be useful as protection against domestic government interference. For example, institutional investors’ voluble concerns probably helped to discourage the removal of frequencies from newly listed MTS in 2000. They do not seem to have helped Yukos much however. Such institutions also seldom exercise their voting rights. They ‘vote with their feet’.
▼ Improving the company’s international visibility and perceived status. An NYSE or LSE listing gives additional credibility, particularly when competing in international markets.
▼ Applying peer group pressure. An IPO helps a company keep up with or get ahead of business rivals. New Issue Profile
There are no hard-and-fast rules about the profile of a successful IPO. There are, however, some guidelines:
▼ As the main objective of an IPO is often fund-raising to grow the business (new shares), investors do not like to see the founding shareholders selling. They are willing to accept some ‘cashing-in’, but this should be modest; no more than, say, 10-15% of the total offering.
▼ The offering size should be US$50 million or more, to attract the interest of international institutions. The larger the ‘free float’, the more attractive the IPO will be to institutions who buy in US$5m-US$10m tranches and who value the ability to trade freely in and out of a stock. Smaller IPOs are of course possible, but fewer investors will be interested and the valuation of the equity may suffer.
▼ Issuers should aim to offer at least 25% of their post-IPO market capitalization to investors. A holding of 25% + 1 shares constitutes a blocking minority in the Russian Commercial Code. Although international investors rarely exercise their voting rights, the existence of such a stake in the public market underlines the issuer’s commitment to the protection of minority rights.
▼ Issuers must present a compelling investment case. This will comprise, inter alia, a credible growth story — dividends are not an issue — and a management capable of delivering it.
▼ Issuers should ‘leave something on the table’ in terms of value. This is always a tricky issue. Investors will only invest if they see some upside in the price they pay for the shares. Issuers naturally wish to maximise their proceeds. The result has to be a compromise or the deal will fail.
Some key considerations
An IPO involves presenting the company and its management, strategy, performance and prospects to potential investors in as clear and credible manner as possible. Regulatory requirements for new issuers differ across listing authorities. Broadly, the listing requirements of the Russian, Ukrainian and other exchanges tend to be less onerous than those of the US and UK capital markets. However, these requirements tend to converge internationally over time and the closer a new issuer can comply with international best practice the more likely its offering will be a success.
To comply with best practice, a new issuer will need to:
▼ Produce consolidated accounts to international standards (IFRS or US GAAP), usually for a three-year period and audited by an international accounting firm. For groups that have formerly been organised around a core of individual shareholders, with each holding differing stakes in subsidiaries, the consolidation exercise can take many months, even years.
▼ Provide potential investors with a high, and probably initially uncomfortable,
degree of disclosure about the companies’ shareholders, organisation and business. This information is presented to investors in the form of a prospectus or offering memorandum, drawn-up by legal advisers to the issuer but the accuracy of which is the issuer’s legal responsibility.
▼ Establish an investor relations function to manage the flow of information to the market and regulators after the IPO and to protect the companies’ management from the sometimes insatiable demands of analysts and media for news.
▼ Establish good corporate governance practices, designed fundamentally to protect minority shareholders’ rights. These include the appointment of independent directors, preferably a majority of the board, and the establishment of compensation and audit committees. In the early stages, these ‘new’ practices can be perceived as an irritating constraint on the original shareholders’ and management’s freedom of action.
Listing Location
This aspect of an IPO normally receives far too much attention. In essence, the decision is a simple one. The key issues are where the stock will receive the best coverage by equity research analysts and who the main international investors are likely to be. In most cases the answer for Russian, FSU and Baltic corporates is a dual listing; in the home market (RTS or Micex for Russia) to ensure membership of the relevant index and research coverage and simultaneously on the LSE or NYSE to capture the Global Emerging Markets investors. For deal sizes of US$50m or less, a local listing will probably suffice.
Both the LSE and NYSE listing processes offer similar assurances of an issuer’s quality and compliance with international standards of disclosure and corporate governance. The LSE process is, however, significantly cheaper than that of the NYSE and involves less legal exposure for the issuer’s shareholders and management than does the NYSE. Many Russian corporates have turned to the LSE as the international issuing location of choice following the enactment of the Sarbanes-Oxley law in the US.
Timing & Process
An IPO is a complex and time-consuming business. IPOs are very seldom completed in under 6 months and, in emerging markets, they can take considerably longer. Over a year is not unusual. The pace is normally set by the restructuring process, designed to create a listable corporate vehicle, and by the need to produce consolidated audited accounts. With restructuring and accounts in place, an IPO can normally been completed within 3-4 months, market conditions permitting.
The main activities occurring in this 3-4 month period are:
▼ Due diligence on the company by investment bankers and legal advisers to produce an indicative valuation range for the offering and an offering circular for distribution to potential investors.
▼ Regulatory approvals from the local listing authority — in the case of Russia, the Russian Federal Service for the Financial Markets (FSFM), and in the case of the UK, the London Listing Authority.
▼ Forming a syndicate of other local and international investment banks to supplement the marketing process and post IPO trading and research coverage.
▼ Production of research on the offering by the banking syndicate’s equity analysts, giving an independent view of the merits of the investment case.
▼ Marketing of the offering via a ‘roadshow’ involving mainly one-on-one meetings between management and investors. This normally takes up to 2 weeks and involves visiting a number of international financial centres to present the investment case.
▼ ‘Bookbuilding’. During the course of the roadshow, the banks’ salesforces contact potential investors and elicit orders for the shares on offer and price sensitivity. At the end of the roadshow, the banks will thus have ‘built’ a book of demand at various price levels (like an economist’s demand curve).
Pricing and allocation. The price of the offer and the allocation of shares to the new investors are agreed, on the basis of the book of demand, in negotiation between the lead bank(s) and the issuer.
Cost
An IPO is an expensive business. Typically, the investment bank’s fees are paid on the basis of success only and are quoted as a percentage of the amount raised in the offering. This percentage varies according to the size of the offering. Fees of lawyers, accountants and communications advisors as well as hard costs, such as printing and roadshow expenses, must be added. Depending on the complexity of the deal, these costs can significantly increase the overall bill.
Advisers
To complete an IPO, an issuer will need to appoint a number of advisers. The key advisers include:
▼ An investment bank, to lead and co-ordinate the entire process from planning through to completion (see below).
▼ Legal advisers to assist the issuer to prepare the offering circular, to advise it on its legal exposure, to communicate with listing authorities etc. It is customary, in the larger deals, for the investment bank leading the deal also to appoint a legal adviser to protect its interests.
▼ A firm of auditors to produce the accounts in the appropriate format and provide a disclosable opinion on them.
▼ A financial PR firm to orchestrate a media campaign to prepare the market for the forthcoming IPO.
The role of the investment bank
This is the most critical appointment. The mandated investment bank — ‘Lead Manager/Global Co-ordinator’ — leads and co-ordinates the whole IPO process through to completion and beyond. In particular, the investment bank:
▼ Advises the prospective issuer on offering structure, maximisation of value, market conditions and timing.
▼ Assists in the selection and appointment of other advisors.
▼ Establishes and manages the deal timetable and liaises with regulators and the other advisers.
▼ Assembles a syndicate of banks, if necessary, to market the deal. Manages the marketing and sale process of the offering.
▼ Advises the issuer on the pricing and allocation of the offered shares.
▼ Assists in the formation of a stable and liquid market for the shares.
▼ Provides regular post IPO research coverage on the company.
DAVID HERBERT ING, Member of The PBN Company’s Board of Directors
ING’s office in London is in the heart of the City. It has also had an office in Russia since 1992. One of ING’s specialisations is the provision of investment banking services to its Russian clients.