Companies choose to raise funds through Initial Public Offerings (IPOs) for a number of reasons.
For example, they allow companies to tap into a wide pool of liquidity that provides capital to fuel future growth. And, as a region blessed with growth-driven corporates and huge pools of liquidity, there is no shortage of IPOs coming to market.
The principle of an IPO is simple: a company offers a percentage of its ownership, or equity, to new investors who acquire a stake in the company by buying its shares. The issuing company receives a capital boost from the funds raised and the investors receive a share of the future performance of the company: a mutually beneficial arrangement.
Within the region, there are two methods of pricing shares in an IPO. The first is to sell shares at a single fixed price. This is the approach taken across much of the region, including for companies on the Dubai Financial Market. The second is the bookbuilding method, used internationally and also the DIFX's method of choice.
In the fixed price method, the company, or 'issuer', values the company and prices the share at a pre-determined price. On the DFM, for example, IPOs are usually sold at AED 1 per share. It is with fixed price offerings that we see high oversubscription levels of, in some cases, several hundred times. Of course, these IPOs are often viewed as a success and the method is popular with investors in the region due to the immediate returns it often generates in the first few days of trading.
However, fixed pricing can lead to an undervaluing of the issuing company as the price of the company's shares at IPO is often lower than a "fair" market value.
As a result, the low price attracts investors and the share price often rises dramatically in the first few days of trading after the IPO, as investors positively revalue the company. For the company, and its pre-IPO shareholders, they may have given away substantial value as a result.
More efficient
The book building method is more efficient as it solves the "leakage" of value often seen with fixed priced IPOs. Here the issuer sets a price range within which the investor is allowed to bid for shares. The range is based on where comparable companies are trading and an estimate of the value of the company that the market will bear. The investors then bid to purchase an agreed number of shares for a price which they feel reflects fair value. By compiling a book of investors, the issuer can ascertain what price range the shares should be valued at, based on the demand of the people who are going to buy them, the investors. In this process supply and demand are matched.
Globally, the book building method is favoured for its mutually beneficial nature: investors get the shares at a fair price that typically has potential upside, and the issuing company receives fair compensation.
However regionally it is likely to take some time to adapt to this method. Issuers clearly have a vested interest in moving to an approach that is more likely to lead to a better price for their companies. This will upset some investors in the short term, who are used to making a lot of money from these fixed price IPOs.
In the longer-term, however, efficient pricing should be seen as a sign of the growing maturity of the capital markets in the region.
- The writer is a Dubai-based financial communications consultant at Capital MS&L.
