Flotation
Part 7: Pricing an offer
The price at which a company is floated is determined by the advice of the stockbroker who, in turn, will assess the likely level of interest from potential investors and draw comparisons between the flotation candidate and currently quoted companies. Potential investors will also make such comparisons. This may allow them more quickly and accurately to understand the business of the flotation candidate, whilst at the same time provide a basis for valuation comparison.
Therefore, the easiest and arguably the best measure of a company is to look at the nearest quoted alternative, or the valuation of the sector into which a flotation candidate is entering.
Assuming a situation where there is a comparable quoted company with a very similar business profile to a flotation candidate, then the flotation pricing would be derived by calculating an appropriate discount or premium to the valuation of the existing quoted company based on the appropriate valuation method of the quoted company, i.e. price earnings ratio, cash flow analysis or asset-based valuation.
The discount or premium will seek to reflect:
• the quality of the flotation candidate relative to the quoted com- parable(s);
• the fact that the quoted company has a track record on the market already; and
• the flotation will be priced to increase by between ten and fifteen per cent when dealings commence, to encourage investors to participate.
In determining the flotation price, it is not a question of getting the highest possible price but of getting the right price. It is neither to the company’s advantage to be over-priced nor to be under-priced. If it is over-priced, then it runs the risk of its share price going below the flotation price in the early stages of its stock market career and once it has done so it may prove difficult to re-establish the shares above the flotation price. If the price does not perform, the ‘currency’ of the company’s shares is less attractive both to investors and to potential acquisition targets. If it is under-priced, then the question of there being a premium to the flotation price is not an issue. Instead the question is whether the company sold too much equity to attain the required funds and whether existing shareholders were disadvan- taged either by selling too cheaply or by being diluted through an excessive issue of shares.
One perception is that stockbrokers will sell an issue as cheaply as possible in order to advantage their own investor clients. There is, however, a flaw in the logic to this argument. If a stockbroking firm establishes itself as only selling flotations cheaply, it will not attract new flotations and therefore its business in that area will dry up. The stockbrokers will typically be looking for the pricing to achieve an appropriate upward movement of the share price in the days 132 Public Equity
following flotation of some 10–15 per cent. At such a premium the vendors and the company issuing new shares should be content that they have not given away too much and new investors should be content that they have had an appropriate initial profit to assist in making their participation attractive.
In terms of how a company can ensure that it gets the ‘right’ price, it should seek to have a clear understanding of how its stockbroker has arrived at the valuation suggested at the very outset. The company should also continue a dialogue on the stockbroker’s views on valuation throughout the period of flotation preparation.
With the right price and appropriate post-flotation support by the stockbroker, and subject always to market conditions, the flotation candidate should not see their share price fall below the flotation price. It may well trade on a plateau for a period and the end of that period may be marked by the announcement of the maiden set of results. The logic is that the market is waiting to see the company’s results before it adjusts the share price significantly from the flotation price.
Poor share price performance post-flotation does matter because the company will typically be floating to increase its access to further equity capital in the future, as well as the equity it raises at the time of flotation. Such future equity might be in the form of a rights issue or placing, or may be in the form of issuing quoted shares to acquire another company (the fact that they are quoted will make them considerably more attractive to a vendor than if they were unquoted and therefore not marketable). Therefore, if the share price goes up, then for the company to raise further money in the future or pay for an acquisition it will need to issue less new shares and therefore existing shareholders will suffer less dilution. If the share price stagnates or declines, the level of dilution will be greater – or worse, it may not be attractive to investors to put up more money or for vendors of acquisition targets to accept shares as consideration.
Low liquidity (ie where shares are traded infrequently) is another problem that affects some companies. Illiquid shares are particularly sensitive to relatively small share transactions and the rises and falls in share price may be pronounced. Many investors prefer to avoid such companies because of the difficulty in buying and selling shares without affecting the price. Liquidity is affected by a number of factors, including the number of shareholders, size of shareholdings and the effectiveness of the company’s stockbrokers.
Illiquidity should be taken seriously by a company. An illiquid share will be an unattractive share to new investors and will therefore limit the potential use of new equity in terms of raising further money and the use of a company’s shares in making acquisitions – ie if the recip- ients under either of those scenarios believe that to sell their shares would prove difficult, then they will not be attracted to them in the first place.
Illiquidity may arise from a tightly held shareholder list. Possibly the original founding equity holders (family or partners) perceive that to release more equity would be to lose control. It may be that they cannot be persuaded otherwise, but most often a single shareholder, or group of shareholders, can exercise control despite holding below 50 per cent, particularly if it is a widely held shareholder base. The Panel on Takeovers and Mergers have, in setting the requirements for any individual, or group of individuals acting in concert, to make a bid at above 30 per cent, indicated their opinion that effective control may be exercised at or above 30 per cent.