More initial public offerings (IPOs) are set to be launched in the region this year, adding to the depth and breadth of the local stock markets. Pricing of new issues using a book-building process will become more common as established companies going public seek to achieve their true value, and regulators realize the importance of adhering to international best practice to attract sophisticated institutional investors.
The IPO market in the region remains strong with more than $5 billion of capital raised in the first quarter this year, up from just $1 billion in the first quarter of 2007. But despite the massive increase in the amount raised, the number of IPOs launched in the Middle East and North Africa region has increased only marginally, with the first quarter of 2008 witnessing 15 IPOs compared with 14 in the first quarter of last year.
Eight of the 15 IPOs were in the GCC, and five of those in Saudi Arabia. The regional figures are in contrast with IPO trends worldwide.
Globally, the amount raised fell by 11 percent to $36.3 billion during first quarter of 2008 compared to the same period a year ago. The total would have been almost half its reported level were it not for the $18 billion Visa IPO.
In 2007, the Middle East IPO markets raised $12 billion through 70 new issues, up from $10 billion through 87 issues in 2006. The largest IPO in Saudi Arabia was that of Al-Inma Bank which ended on April 16, with 1.05 billion shares sold raising SR10.5 billion ($2.8 billion). Because it is a start up, the IPO was issued at the nominal price of SR10 and the shares were 74 percent oversubscribed.
Although common in developed markets, book building is still a novelty in the Middle East region. With the exception of the Dubai International Financial Exchange (DIFX), the Egyptian stock market, and the Saudi stock market where the pricing of selective new issues is done using a book building process, the normal practice so far has been to float companies at a fixed IPO price.
This price is normally based on the company's assets, cash flow and future profitability, as determined by one of the big four accounting firms. The regulator would review the valuation method and approve the price arrived at using this method.
According to the fixed price method, the valuation of the company is divided into a certain number of shares at an established nominal price of say SR10 in Saudi Arabia, AED10 in the UAE, BD1 in Bahrain, or QR10 in Qatar. Fixed pricing of IPOs are intended to benefit retail investors and is also a legacy of a time when only new companies could list shares. In the past, the majority of listings have been in start ups and green-field companies which made it difficult to add a premium on the IPO price.
Share prices normally surged upon listing and investors benefited. This has encouraged wider participation by both large and small investors, guaranteeing the oversubscription of the IPOs. There has been a general perception that new share offerings by government owned companies in the region is a form of wealth distribution, and governments want to make sure that retail investors benefit by subscribing to the IPOs.
It has become evident now that the fixed price method of the IPO is likely to discourage companies who want to go public and aspire to command a fair value for their shares. From the issuer's perspective, building a book means finding a fair price in the market that would attract enough investors for the shares being floated. A price at which demand and supply are in equilibrium, i.e. there is no suppressed demand that would translate into a guaranteed surge in the price upon listing. The book-building would arrive at a price that would reflect the true value of the company. The investment bank leading the process will value the company and come up with a price range at which investors will be asked to place their bids. Based on that, the "equilibrium floatation price" is then determined. Building a book means investors would know before the shares start trading how many they will receive and at what price.
It is not clear how quickly the practice of book-building for new IPOs will be adopted in the region. It is under serious consideration in the UAE, and it is likely that 2008 will see the first IPO listed on the local exchanges executed on a book building basis. In Kuwait, Qatar and Oman, the issue is not pressing as there are few IPOs coming to these markets. Moving to a book building approach would require a change in the rules, strong support from the regulatory authorities, and a comprehensive media campaign to inform retail investors of how the book-building approach differs from the fixed price approach. Here the regulator's role becomes that of a watchdog, i.e. monitoring market practices without setting the IPO price or necessarily approving it. It is the demand in the market that would ultimately determine the price.
The decline in the share prices of companies who issued their IPOs at prices reached by a long process of book building when trading in the secondary market started, such as the Kingdom Holdings on the Saudi stock market in June 2007, and the floatation of DP world and Depa on the DIFX, is an indication that the majority of retail investors do not yet fully understand the dynamics of the book building process. Market participation should lower their expectations of a speculator performance of the IPO price after listing.
They need to realize that book-building means the floatation price is much closer to the market fair value at the time of the IPO and doubling or tripling of the price becomes less likely.
(Henry T. Azzam is chief executive officer, Middle East & North Africa Region, Deutsche Bank AG)
By Henry T. Azzam
Arab News 2008
