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IPOs: It’s all in the timing

THE PAST five years have seen a drop in company listings as the lingering effects of the 2008 global crash have created market volatility and soured investor appetite. Macroeconomic factors such as the threat of double-dip recessions, financial sector bailouts, and uncertainty over the euro have prompted companies to play it safe and wait for more signs of economic recovery.

But fortunes are changing. The UK economy continues to recover and the risk of a crisis in the eurozone has receded. “Given that only a year ago, there were real worries that the UK was heading for a triple-dip recession, the market for IPOs is now buoyant,” says Chris Searle, corporate finance partner at BDO.

While the desire for capital raising (as well as improving the company’s profile) may have returned, experts warn that companies still have to tread carefully and assiduously plan to ensure that the initial public offering (IPO) runs smoothly.

IPO graphThere are several considerations that determine the market on which the company will most likely list. The first is size: large companies with turnovers of more than £250m will fare better on a large exchange, such as London or New York, while small companies tend to list on the Alternative Investment Market (AIM) in the UK, which has less onerous requirements (though still stricter than those a private company would face).

For example, companies seeking an AIM listing are not subject to significant admission requirements (just two years’ trading history) or the same level of corporate governance criteria.

Clock-watching
Another issue is timing. The IPO must take place when there is likely to be strong investor interest: the most active periods tend to be spring to early summer, and between September to December. Conversely, the run-up and immediate aftermath of key holiday seasons – August and Christmas, for example – usually see a drop-off in IPO activity.

However, given the recent five years of market volatility, there is no guarantee what the state of the economy or stock market performance will be like in the period between announcing an IPO and actually going public, and luck may not go your way. For example, a listing on a major exchange can take up to three years to plan (though the turnaround process for the majority of companies is usually under a year – some being as quick as three months on smaller exchanges).

Furthermore, if the company loses contracts or customers and posts a poor set of results in the run-up or immediate aftermath of the flotation, investor confidence will take a serious dent.

Anthony Foy, CEO at online file-sharing provider Workshare, has been involved in leading three companies to IPO. In 1996 he worked on Redbrick Software’s listing on NASDAQ, as well as on Broadbase Software’s listing on the same exchange in 1999 at the height of the IT bubble. While intense, both were relatively quick turnarounds. However, the last IPO he worked on with Dutch technology company Interxion proved more difficult, after attempts to list on London’s main market and NASDAQ fell through.

“We were trying to go public at the height of the economic crisis and market conditions were not right. We successfully listed on the New York Stock Exchange at the third attempt but the whole process took five years. It was very expensive; it took a lot of management time; and the due diligence work – hiring advisers and setting up meetings and roadshows – was a significant distraction from the day job, which is to create value and drive profits,” he says.

Name a price
An IPO invariably means putting a price on a company – and this is not easy, which means that companies may not be able to raise the amount of cash they think the business is worth if investors disagree with the valuation. Tech and pharmaceutical businesses, for example, are not always cash-generative: their value is determined by the amount of intellectual property and patents that they hold.

Wouter De Maeseneire, professor of corporate finance at Belgium’s Vlerick Business School, says that the valuation process can “make or break a listing”. “The whole point of a valuation depends on future cash flows, and these are difficult to predict,” he says. “Consequently, the process becomes subjective and involves guesswork: looking at the earnings per share ratios of other companies in the same sector may provide a few indicators, but it is not an exact match, so how useful is the comparison?”

One of the most popular ways to guarantee a good reception for the announcement of an IPO is to have already secured a substantial amount of the demand for the deal before its public unveiling. Roadshows – where company directors, including the FD, go out and meet investors to test the water and see whether they would apply for shares – is seen as a “necessity”, but it requires intense preparation and can effectively take up three weeks of senior management’s time with back-to-back meetings.

Other methods to gauge investor interest pre-listing are also becoming more popular. “Pilot fishing” gives a select group of important and trusted investors a first look at a deal before it is publicly launched. Running a “shadow book” takes this a stage further, with the bookrunners of a deal looking for relatively firm indications of demand from potential investors. “Grey market” analysis – whereby investors can trade shares in a company before its official IPO opening day – can also be a good indicator of whether a company is under- or over-valued prior to listing.

Grey matters
Brenda Kelly, chief market strategist at derivatives broker IG, says that the “grey markets” analysis that it ran last year on both the Royal Mail and Twitter IPOs were more accurate in predicting prices than bankers and their advisers.

“On the Twitter IPO, through analysis of averages, the grey market predicted shares at the end of first day of trading would be worth $44. They ended up at $45.06 – incredibly close, particularly when you consider the price set by Twitter and the bankers was $26. As for the Royal Mail, the government valued it at 330p a share, while retail investors valued it at 500p per share, which was much closer to the mark,” she explains.

In the end, those companies that are going to whet investor appetite are those with a strong financial and management record. “Companies that are most likely to impress investors ahead of a float are those that have a strong market position, strong revenues, and intellectual property and patents,” says Alexei Callender, director, corporate finance at Zeus Capital.

“They also need to have a strong, experienced management team in place with a clear growth strategy that has a plan to return yields of between 5%-10% to investors every year. Investors want strong returns – it’s that simple.” ?

Case study

blur Group, which operates an online business services exchange that allows organisations to invite pitches for work projects, listed on AIM in October 2012. According to Barbara Spurrier, its company secretary, the decision to raise capital through an IPO was taken in April that year after the company had secured about £1m in angel investment funding.

“We thought we could possibly raise another £1.5m through angel funding in the future, but such avenues would then be exhausted. We also did not want to take the venture-capital route and lose a majority stake of the company, so a stock market listing was seen as the best option,” she explains.

Spurrier says that there are two key considerations that need to be made in advance of an IPO. “Get an analyst who properly understands your business and what you are trying to achieve from the IPO, because this is the guy who is going to pitch your company to investors,” she says.

“Secondly, ensure that you have the right board and management structure with strong and experienced non-executive representation in place before you embark on a roadshow ahead of an IPO. It gives investors more confidence if they can see that the board structure and composition follows best practice guidelines ahead of any listing.”

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