Jun 11 2012
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GIB Capital's Al-Ghamdi: "The financial advisor's role [in the IPO process] is even more critical now"
IPO activity in the Middle East and North Africa has been sluggish as markets and investors take their time to overcome the effects of a global economic meltdown. As green shoots of recovery appear in the regional IPO space, analysts believe that every step needs to be taken with care to ensure that these green shoots continue to flower. A key role in the process of taking a company to IPO is played by the advisors and intermediaries. Khalid Al-Ghamdi, senior Vice President and Head of Corporate Finance at Riyadh-based GIB Capital , believes that the financial advisor must ensure that a company seeking to issue new shares completes every step efficiently and effectively. He tells Zawya in an interview that there are a number of issues that need to be considered before an IPO can be successful. Al-Ghamdi also discusses trends in the region's capital markets and on IPO activity.
Excerpts from the interview:
For what purpose are companies raising most of their capital these days - debt refinancing, operations, expansion, acquisitions...?
Over the last few years, companies have been primarily focused on either refinancing their existing debt or raising additional debt to support their growth operations (typically financing the cash conversion cycle). However, the trend during late 2011 changed and we've started to see increased activity from borrowers who have approached banks to either obtain financing for their expansion plans or acquisitions. It is important to note that banks mainly focus on clients who have a strong track record when approving long-term funding for expansions and acquisitions.
Raising working capital and raising expansion capital are two very different undertakings. Working capital is generally funded by commercial banks through financing lines. There have been few, if any, liquidity issues in Saudi Arabia for running businesses; credit lines have been easy to obtain and at good pricing. Expansion capital, whether raised through equity investors or through financial institutions, has been somewhat difficult to raise, until recently. Again, expansion capital would still be easier to raise for businesses that are already in operation. Banks and financial institutions were a little hesitant to provide financing for expansion capital during the difficult period of 2008-2011, but seem to be easing up on their financing criteria now.
At the same time, the recent jump in the stock markets means that raising financing through public offerings has become more attractive again. We have a number of IPO mandates in the pipeline which we have signed recently, indicating that companies are more open to tapping the capital markets now than they have been in the recent past.
When a company approaches you for managing its IPO, on what criteria do you base your decision whether to take on the mandate?
We usually base our decision on the following criteria which we believe are essential for a successful IPO:
- Equity story
- Stable revenue base and history of financial strength
- Strong market position in an attractive industry sector
- Credible strategy to increase and/or maintain its competitive advantage
- Experienced management team with a proven track record
- Appropriate capital structure that enables future growth
- Clear uses for the IPO proceeds if the IPO will raise additional capital from the public
- A strong corporate governance structure
Is the issuer company also involved in the decision-making process of its IPO?
Ultimately, the decision to go public rests with the company. As an advisor, our job is to guide the company through the process and deliver results that are acceptable to the issuer. The continuous involvement of the company will obviously be critical to the success of the IPO.
The company should ideally start by appointing an "IPO project team", responsible for the day-to-day activities relating to the IPO. This project team will work closely with the advisors within their respective work streams.
The IPO process will require several decisions from the Company including:
- selecting the participants in the IPO process, such as the lawyers, underwriters, accounting advisors, market consultants and PR and media advisors
- approval of the restructuring/capital increase, if any
- approval of the IPO terms
- approval of the final share price range, in the case of a premium offering
- approval of the road show presentation and marketing campaign
All dealings between the company and its financial advisor should be on an arm's-length basis. It is also advisable for a company to avoid appointing a financial advisor with which the company has cross-shareholdings or cross-directorships as this could be seen as a serious conflict of interest.
For capital market transactions, the key hurdle is the underwriting agreement where the financial advisor, more often than not, acts as underwriter to the transaction. In such instances, it is essential that both the issuer and the financial advisor be advised by independent legal counsel.
What role do you play in the success of an IPO? What other factors determine success or failure?
The right financial advisor has to have the experience to take its client through every step of the IPO process. The IPO process is complicated and can be tedious. It is the financial advisor's responsibility to take the company by the hand and ensure that each step is completed effectively and that impediments are identified and overcome on a timely basis.
This means that the application for the IPO should be of superior quality, that any and all due diligence issues are identified, discussed and rectified before submission of the IPO application to the regulator. The financial advisor should also assist the company with the valuation exercise and at the same time manage expectations of the value that the market would be willing to place on the company. The financial advisor must also assist the company ensure that the corporate governance structure in place not only meets the minimum criteria for listed companies, but also meets the expectations of the investors.
After ensuring the submission of a high-quality IPO application to the regulator, the financial advisor has to liaise between the regulator and the company, and meet any additional information requirements. Once the IPO application reaches the approval stage, it is the financial advisor who has to start marketing the IPO to ensure coverage.
Ultimately, investors make the decision to invest in an IPO based on the disclosures made available, the quality of earnings and the general investment climate. However, it is the financial advisor who has to prepare the company for the IPO and to ensure that investors have adequate information to make the investment decision.
In Saudi Arabia, all premium-priced IPOs have been institutionalized. This means that mutual funds and other sophisticated institutional investors must first cover the IPO 100% before it is offered to the general public; an offering which is not first covered 100% by institutional investors will not be allowed to go public. As a result, the financial advisor's role is even more critical now, as the company's business case has to be presented to institutional investors who carry out sophisticated analyses before making the investment decision.
The financial advisor and underwriter are often the same entity; in what ways do their roles or duties differ?
The financial advisor and underwriter will certainly be the same entity in most instances. If the issue size is large enough, the financial advisor may invite one or more other institutions to participate in underwriting the transaction.
The financial advisor manages the overall transaction, including structuring, documentation, due diligence, valuation and regulatory matters. The underwriters supplement the financial advisor's role by giving the commitment to take up the shares that are unsold in the IPO.
The financial advisor, in most cases, also takes up the role of the underwriter, at least partially, to give comfort to investors that the financial advisor is also committed to the issuer, the transaction and to the valuation.
Explain to us in brief the process you follow pre and post IPO.
A critical part of the pre-IPO process is writing the equity story to demonstrate the company's growth potential and plans for the future. Initial challenges revolve around business structure and corporate governance. In many cases, non-core activities have to be carved out or additional businesses combined to put together the vehicle that eventually goes public. This is a time-consuming exercise in which we closely coordinate with the company and its shareholders. It is essential to obtain the buy-in of all shareholders and their representatives.
This is followed by detailed legal and financial due diligence on the company, where any and all legal and accounting issues must be resolved. At the same time, we prepare the offer documents, valuation models and arrange underwriting. We also assist our clients in implementing corporate governance practices that meet investor expectations as well as the regulatory requirements that publicly listed companies must adhere to.
As the IPO application reaches the approval stage, the marketing effort is geared up. Different investment banks take different approaches. GIB Capital 's approach is to meet every institutional investor individually in a market-sounding exercise on a "no names" basis prior to official approval of the IPO. If necessary, and depending on market conditions, we might also go back to investors after the IPO has been announced, this time using the issuer's name, to further generate excitement about the issue. Feedback thus generated is used to prepare for the road show, so that management is aware of all possible questions that might arise and is prepared to respond to them.
We also assist in building a positive public image. A positive image cannot be developed overnight; it can take months or even years to accomplish, so the earlier a company gets started, the better. A positive image can enhance the initial marketing effort and maintain the public's interest in the stock in the aftermarket.
Post-IPO, the issuer's strengths must continuously be marketed so that the stock price performs well in the after-market. This means that the company must share information through periodic disclosures to keep investors abreast of all financial and non-financial developments.
In which cases would a road show become an option?
Road shows in Saudi Arabia are carried out for premium-priced IPOs only. Road shows are conducted to cultivate institutional investor interest and generate demand for the IPO. It represents an essential part of the issuing company's marketing campaign and its success is critical to the success of an offering.
During and after the road show, the financial advisor surveys the level of demand from institutional investors for the offered shares, in a process known as book-building.
This book-building exercise, also known as the process of price discovery, involves the participation of institutional investors in bidding for an allocation in the IPO at a range of prices. After the book-building process is complete, the offer price is determined based on the highest price at which the offered shares are fully subscribed, or covered.
Road shows are not required for par offerings in Saudi Arabia, which are offered directly to retail investors without involving institutional investors.
How do you decide on the allocation of shares between investors (retail, institutional, funds, etc.)?
Par offerings are always allocated 100% to retail investors in Saudi Arabia. Currently, all premium-priced offerings must first be offered 100% to institutional investors. Once the offering has been covered 100% by institutional investors, the IPO is then offered to the retail investors. Based on demand from retail investors, up to a maximum of 50% of the IPO shares may then be allocated to them by scaling back the institutional tranche.
In summary, the shares allocated to institutional investors would be a minimum of 50% of the shares offered, and shares allocated to retail investors would be a maximum of 50% of the shares offered.
Institutional investors in Saudi Arabia comprise mutual funds, authorized persons investing their proprietary funds, insurance companies and listed companies with discretionary portfolios managed by authorized persons. Depending on the size of the IPO, the universe of institutional investors can be expanded to include family offices of large business groups as well as high net worth individuals. Within the institutional tranche, preference in terms of allocation is given to mutual funds with a large investor base in order to spread the shareholding in the issuer as extensively as possible.
We have seen many companies in the MENA region announce plans for IPO and then delay its issue. What factors would mandate a delay?
In recent years, particularly since 2008, many companies delayed their IPO plans because of the uncertain market conditions that accompanied the global economic downturn. While the regional economies stayed strong, particularly Saudi Arabia, there was still a strong overhang from the global economic situation that made investors hesitant and companies tentative in their plans to go public. In fact, high volatility and depressed valuations put the brakes on global IPO markets, not just the MENA region.
Other reasons may include issues that arise when a family-owned business prepares to go public. Examples include producing financials on a timely basis, addressing legal and financial due diligence concerns, carving out non-core assets or business lines that are not appropriate to the vehicle that is planning to go public. These are major issues and not every company is willing or able to deal with such issues in an appropriate or timely manner.
Unfortunately, there are many companies that want to go public but will not be able to do so because of such reasons. Similarly, there are some very impressive companies that will be a good fit for the capital markets but have taken the strategic decision not to offer their shares to the public at this particular time.
How much of today's corporate finance needs are met via debt and how much via equity? How has this ratio changed over the past five years?
This is a strategic decision taken by the shareholders and directors of a company. The larger corporates are certainly aware of the importance of debt for their capital structures and will continue to use appropriate amounts of leverage.
However, for family-owned businesses, we have generally seen an aversion to commercial debt for a variety of reasons; most family-owned companies prefer to be as much equity-financed as possible. The resultant strength of their balance sheets played a strong role in many companies' weathering the recent economic downturn as debt repayments did not put significant pressure on the cash flows.
Having said that, most companies would benefit from a measure of commercial finance on their balance sheets, which would lower the cost of capital and increase valuation while at the same time unlock shareholder wealth through dividend payouts.
Has the cost of raising finance changed over the past five years?
Commercial lending rates have declined over the past few years, a part of the central banks' initiative to spur economic activity. At the same time, we have also seen a decline in financial advisory fees for IPOs. This happened because of the multitude of investment banks that opened up, all promising to deliver the best advisory services possible, driving pricing down. However, managing IPOs is a complex process, and not every investment bank will have the capability to deliver on their promises.
The market has also started realizing that experience and expertise come at a premium, and the larger investment banks have started considering revising fees upwards.
Where would you rank IPOs in comparison to other methods of financing and investing?
IPOs are not just a method of raising finance. IPOs are also a way of ensuring continuity of business, introducing mandatory corporate governance and disclosure requirements; bringing in independent directors; and subjecting the company to external scrutiny. The companies that we have taken public mostly approach IPOs towards such ends.
Private placements of equity, on the other hand, offer lower valuations. At the same time, they can be used to bring in additional expertise at board level without subjecting the company to the disclosure requirements of a listed company. In many cases, a private placement of equity can be a precursor to an IPO.
Companies do explore alternative exit strategies to an IPO, although public offerings are generally seen as providing better valuations, access to capital, visibility and credibility.
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