Brian Gaynor 's Opinion

Investment columnist for the NZ Herald

Brian Gaynor: Kiwi companies getting it wrong with IPOs

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Banks, private equity and vendors adopting a short-sighted strategy

NZX chief executive Tim Bennett (left), Gentrack chief executive James Docking (centre) and chairman John Clifford ring the bell as the company lists on the NZX. Photo / Brett Phibbs
NZX chief executive Tim Bennett (left), Gentrack chief executive James Docking (centre) and chairman John Clifford ring the bell as the company lists on the NZX. Photo / Brett Phibbs

The sharemarket performance of recent IPOs, in New Zealand and overseas, has been extremely disappointing.

The problem is that investment banks, private equity investors and other vendors have adopted an incredibly short-sighted, profit maximisation strategy.

This short-sightedness means vendors receive a full price when they sell out, but the poor sharemarket performance of many of these floats has a negative effect on investor confidence.

The word "greed" has been used to describe some of these initial public offerings.

BlackRock, the world's largest investment manager, has been particularly critical of European IPOs. The asset manager claims 38 of the 104 European IPOs it tracks are trading below their 2014 IPO price.

A senior BlackRock executive has strongly criticised companies brought to the market by private equity investors.

He has been particularly critical of "the failure of companies to achieve stated financial and business targets even after one or two quarters".

That sounds like Gentrack in New Zealand.

One of the problems in Europe is that hedge funds have been shorting private equity IPOs because they believe many of these companies are significantly overvalued.

The share prices of eDreams Odigeo and Bravofly Rumbo, Spanish and Swiss online travel companies, have more than halved since listing this year.

There hasn't been any widespread shorting of IPOs in New Zealand, but their performance has been disappointing.

This has had a dampening effect on investor sentiment and the domestic sharemarket.

The first point to note about the nine NZX new entrants this year is that all set the final IPO price within their indicative share price range. This is in contrast to the United States, where only 38 per cent of this year's IPOs have been set within the share price range indicated by the company.

Of the rest, 31 per cent were above and 31 per cent below.

Only two of the New Zealand IPOs, Genesis Energy and Gentrack, were priced in the top half of the indicative price range.

Our companies take an inflexible approach to price setting, as shown by Hirepool which pulled its offering when it became clear the IPO price would be below the indicative price range.

The next point to note is that only three of our IPOs are trading above the issue price and four are below (Vista lists on Monday and Eroad on Friday).

A $1000 investment in each of the seven listed companies would now be worth $6888 or 1.6 per cent below their combined purchase price.

The next point to note is that of the $1.65 billion raised through the nine IPOs, $1.39 billion, or 84 per cent, has gone to existing shareholders and only $261 million to the IPO companies.

If the partial privatisation of Genesis Energy is excluded, 71 per cent of the IPO proceeds have gone to existing shareholders and only 29 per cent to companies to fund growth or repay debt.

These statistics are one of the most disappointing features of the NZX, because they show that domestic owners prefer to use IPOs as an exit strategy rather than an opportunity to raise new capital to expand their company.

Many of our younger entrepreneurs are trying to emulate Rod Drury and Xero, yet there is a big difference between the current floats and Xero's 2007 IPO.

Xero issued 15 million shares at $1 each and all of the $15 million raised went to the company, whereas most of the IPO money raised in recent years has gone to existing shareholders.

Metro Performance Glass was the archetypical private equity IPO.

The company raised $244.2 million through the IPO with $230.5 million going to existing - mainly private equity - shareholders and the remaining $13.7 million going to the company.

But as $10.9 million of this $13.7 million has been used to pay costs associated with the offer, new shareholders have effectively met the costs associated with the sale of shares by pre-IPO shareholders.

New shareholders now own 77.6 per cent of Metro Glass, pre-IPO private equity investors 18.5 per cent and senior management 3.8 per cent.

Private equity and senior management hold two of the five board seats even though they own only 22.3 per cent of the shares.

Two of the three independent directors are unlikely to have a deep understanding of Metro Glass because they were appointed to the board on July 5, only two days before the prospectus was registered.

This board structure has been criticised by fund managers in the Northern Hemisphere because newly-appointed directors are unlikely to have a deep enough understanding of an IPO company to fully determine whether the prospectus forecasts are realistic.

The issue regarding the most appropriate board structure has been raised by Gentrack's profit downgrade only five weeks after listing on the NZX.

Gentrack's IPO involved the sale of $12.1 million worth of shares by chairman John Clifford, $11.8 million worth by chief executive James Docking and $1.3 million by fellow director Leigh Warren.

The two additional Gentrack directors are Andy Coupe, who was appointed on April 23 this year, and Graham Shaw, appointed on March 26. The Gentrack prospectus was dated May 26.

Coupe is a former senior executive of UBS, Gentrack's IPO lead manager.

Gentrack shocked investors on August 1 when it announced that the net profit after tax for the year ended September 30, 2014 was expected to be in the range of $2.5 million to $2.8 million compared with the prospectus forecast of $3.7 million.

The company blamed the downgrade on two contracts. One involved a dispute with a customer and the other was "a delay in signing a substantial upgrade contract with an existing customer".

The company went on to say that there would be no change to the forecast dividend for the year to next month, and the outlook for the next year "remains as forecast in the prospectus".

There is absolutely no suggestion that directors misled shareholders, but the profit downgrade raised four important issues:

The newly appointed, non-selling directors probably did not have enough time to fully understand all the issues that affect the company's profitability.

Selling directors have an inherent conflict of interest because a reduction in the prospectus profit forecast means they will get a lower price on the sale of their shares through the IPO.

The lead manager's fees are usually a percentage of the proceeds raised - nearly 4 per cent in the case of Gentrack. There is no incentive for investment bankers to insist on a conservative profit forecast because this will only reduce the IPO price and their fees

Gentrack's lead manager fees were mainly dependent on the IPO price; they were not contingent on the company's post-IPO performance.

The Xero IPO had far fewer inherent conflicts of interest.

Lead broker First NZ received a fixed fee of $240,000 - equal to 1.6 per cent of the $15 million raised - and none of the existing shareholders sold shares in the IPO.

Rod Drury sold his first Xero shares - 1 million shares at $1.45 each - three years after the IPO.

This is a far better approach than recent IPOs because the interests of pre-IPO and post-IPO shareholders are more fully aligned and and there is far less prospect of conflicts of interests between these two groups.

Brian Gaynor is an executive director of Milford Asset Management, which holds shares in Genesis Energy, Serko, Gentrack, Scales Corporation, Metro Performance Glass and Vista on behalf of clients.

- NZ Herald

Brian Gaynor

Investment columnist for the NZ Herald

Brian Gaynor has written a weekly investment column for the Weekend Herald since April 1997. He has a particular passion for the NZX and its regulation. He has experienced - and suffered through - the non-regulated period prior to the establishment of the Securities Commission in 1978 and the Commission’s weak stewardship until it was replaced by the FMA in 2011. He is also a Portfolio Manager at Milford Asset Management.

Read more by Brian Gaynor

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