Flotation
Part 2: Suitability for flotation
There are a number of technical requirements a company has to meet to qualify for admission to public markets. In addition to those there is the equally important requirement that the company must be attractive to potential investors.
The principal technical requirements and the general profiles of the Official List (the main market of the London Stock Exchange), AIM (the second market of the London Stock Exchange) and NASDAQ Europe (a Brussels-based market affiliated to NASDAQ in the USA) are as follows:
116 Public Equity
Technical requirements of the London Stock Exchange and NASDAQ Europe
Official List AIM NASDAQ
Europe Minimum proportion 25 per cent no minimum 20 per cent of shares in ‘public’
hands
Minimum financial 3 years* no minimum no minimum
track record (but need
R1m PBT) Minimum track record ‘appropriate no minimum no minimum of management within expertise’
the business
Last audit within 6 months no requirement within 6 months (135 days, in
some cases) Minimum total asset no minimum no minimum no minimum value at flotation
Minimum capital and no minimum no minimum R10 million reserves at flotation
Minimum aggregate £700,000 no minimum no minimum share value at flotation
Number of companies 2,270 612 50
on the market**
Aggregate value of £4,097 billion £11.126 billion R8.7 billion market**
Number of flotations 135 198 9
in 2000 calendar year
Funds raised on £10.836 billion £1.395 billion R468 million flotations in 2000
calendar year
Aggregate value of £53.35 billion £5.419 billion R2.675 billion flotations in 2000
calendar year
* There are certain limited circumstances where an applicant to the Official List will not need to meet these requirements.
** Derived from the most recently published information for each market.
The criteria of investors are somewhat different. They are seeking a sufficient return to balance the risk of the equity investment. There is no such thing as a typical flotation candidate, but core traits that investors will be looking for are:
• a business with a defined, realistic strategy which will achieve increased returns for both existing and new equity shareholders;
• a capable management team to implement and control that strategy; and
• a historic demonstration of the quality of the business and manage- ment – most likely demonstrated through historic financial growth.
Investors will prefer to see a track record for both the flotation candidate and its management. If investors are being asked to pay a high price for shares because of an expectation of substantial growth over the next few years, it helps credibility if the company has demon- strated substantial growth over the previous few years. Similarly, if growth is largely to come from acquisition, then investors will consider whether the management team has a proven record of making successful acquisitions. In both these scenarios, history lends credi- bility to the likelihood of future outcomes and in doing so potentially reduces the risk in the eyes of the investor.
Most companies going to the market are valued at below
£100million (in terms of market capitalisation) at the time of flotation and the principal institutional investors will therefore be the ‘small company’ funds. Small company funds are generalists in the main – ie not limited to any particular sector specialisation. They are able to invest in a wide range of potential flotation candidates provided they believe that the growth prospects of their investment are suitable to meet their particular risk/reward requirements.
There are, at any one time, certain business sectors that are viewed by investors as being able to provide excess returns and are consequently more popular with investors. Caution should be exercised, however, as investment fashion can be a double-edged sword. The dot.com flotation boom of late 1999 and early 2000 clearly illustrated that even professional investors can get carried away by market euphoria. Many of those companies that did float subsequently underwent huge internal and market trauma and for every successful float there were many more companies that failed to get away, frequently having incurred significant costs along the way. The lessons for all revolved 118 Public Equity
around the dangers of early stage companies and/or inadequately thought-out business plans. Consequently it is likely to be some time before investors flock to invest in any companies without substantial existing businesses and demonstrable track records.
Although there is a vast amount of money invested in public equity markets, it must be remembered that the supply of cash is not infinite and investors will always search out the best returns. The laws of supply and demand apply and it is easier to market the flotation of a company if it is in a sector that is popular with investors than if it is in a sector which is in the doldrums.
All this is not to say that companies with a complex or difficult to understand product, or diversified range of business do not make successful flotations, but it may be harder to achieve, and that fact may ultimately be reflected in the valuation.
What investors tend to like least is uncertainty, particularly post the dot.com boom and bust referred to above. With certainty of return and certainty of risk, an accurate assessment can be made of what the appropriate price would be to deliver the investors’ required return.
Unfortunately, we do not live in an environment where certainty is stock in trade. The art of investment is based on uncertainty. However, the lesson here is to deliver to the investor as much certainty as possible in preparing a company for flotation. A period of ‘grooming’
prior to flotation is very wise. The grooming period may vary between three months and two years, dependent on the circumstances of the company. Typical areas that might require attention in a growth company prior to flotation would be:
• strengthening the management team, which may be a reflection of the growth of the business or to reduce dependence on key personnel;
• prioritisation of business growth;
• improvement in financial controls and reporting – often in a fast growing company this vital aspect lags behind the growth in the company; and
• identification of knowledge gaps and sourcing of appropriate non- executive directors to fill these.
It is best to present an investment opportunity in a focused business to potential investors. The more focused a company is about what it is seeking to achieve and how it plans to achieve it, the simpler it is for
the investor to assess the potential likelihood of success and hence the risk and return. Typically, institutional investors will mitigate the risk of any particular investment going wrong by way of holding a port- folio of stocks. There is, therefore, arguably no reason for any one company to diversify its risk by investing in unrelated areas and it should instead focus on core activities. Although there is a converse argument to this, the low stock market rating of companies which have heavily diversified and are described as ‘conglomerates’ reflects the investment community’s view of which is correct.
Additionally, the simpler and more focused the opportunity that the company represents, the easier it is to get that across to potential investors. In considering the amount of time that an institution will have to consider a potential flotation candidate, one must look at how many other flotation candidates an institution may be reviewing, as well as the number of already quoted companies that they are looking after in their portfolio; their time is limited. Typically, the marketing of a flotation candidate to institutions will comprise of a short analytical document, which will give the stockbroker’s view of the company’s business case; the prospectus, which is a legal document that forms the basis of the investment; and a number of meetings with institutional investors which typically last about 45 minutes to an hour. The marketing of a flotation candidate is considered more fully in Part 6.