Investopedia defines an Initial Public Offering (IPO) as "the first sale of stock by a private company to the public. IPOs are often issued by smaller, younger companies seeking the capital to expand, but can also be done by large privately owned companies looking to become publicly traded. In an IPO, the issuer obtains the assistance of an underwriting firm which helps it determine the best offering price and the time to bring it to market".
So that is Investopedia's definition but does the IPO market offer the "free lunch" that some participants would have us believe it does? When we read in the Herald that a new company is looking for capital should the average retail investor buy shares? Will they be a bargain? Are there shares available?
Academic research about IPO's and their subsequent performance says no to questions one and two and portfolio management (risk) considerations invariable flag an emphatic no to the first question as well. The reality of the murky local IPO market is that the answer to the last question is that the availability of IPO stocks to Joe Public is usually inversely proportional to their attractiveness.
Let's examine each issue in turn.
This year we have had a lot of IPO activity and no end of back slapping and smiles for the camera but whilst IPOs are undoubtedly good news for the Stock Exchange and brokers it's not at all clear that a focus on new issues is a sensible move for Mum and Dad investor. Warren Buffet, arguably the world's most successful investor, warned a few years back that we are unlikely to find too many bargains in the IPO markets : "In an IPO the sellers decide when to come to market so its way less likely that it's going to come at a time that suits you" he said.
His partner, Charlie Munger was a bit more blunt "the average person buying IPO's is going to get creamed". Stockbrokers around the world love quoting Mr Buffet but for some reason his views on IPO's haven't got much publicity! That's because the new issue business is big business - higher than usual margins and fat profits. According to the London Financial Times the average cost to a company to do an IPO is around 6 per cent - 7 per cent of the market value of the stock. In contrast institutional broking rates get down to 0.5 per cent and below. The Feltex IPO for example disclosed fees of $21.5 million which at $1.70 share and a company valuation of $250 million came in at around 8.5 per cent.
So whilst IPO's are good for intermediaries what historical research there is on the subject suggests that investors would do better as Mr Buffet suggests by looking for bargains amongst those stocks already listed.
One of the most exhaustive studies of IPO performance was published in the Journal of Finance in 1995. It looked at about 5,000 US IPO's between 1970 and 1990. Investors who bought at the market price on the first day of trading and held the stock for five years achieved an annual return of 5 per cent. Investors who invested in existing listed companies of the same size on the same day as the IPO's were purchased achieved a much higher five year compound return of 12 per cent. According to the authors : "The lessons from studying the IPO market are clear. If you can get an IPO at the offering price, it is often a great buy. But don't hold on! The subsequent performance almost always disappoints."
There are two obvious problems with implementing a "sell immediately strategy". Firstly if you are lucky enough to get shares in the better IPOs and you sell straight away you are likely to attract the attention of the tax man. This however is unlikely to be a problem because actually getting shares in the best IPOs is more easily said than done.
Just recently a company called GeoOp listed on the NZX and there was substantial media coverage of the successful float. GeoOp shares were issued at $1.00 and within three days were trading at $3.00. Nice work if you can get it. What the coverage didn't say is that it appears that you needed to be well connected to get stock in the issue. The shareholder list reads like a who's who of the NZ finance scene and includes many former members of the Stock Exchange, the ex Chief Executive of the Stock Exchange and lawyers and members of the local investment banking world.
I asked the GeoOp Chairman, Mark Weldon, how the shares in GeoOp were allocated. He said that GeoOp was not an IPO, "it was a private capital raising with an offer made to habitual investors and then compliance listed on the NZAX". In terms of the private capital raising, "we looked for a mix of strategic, industry and other investors to create a balanced register". So there you go.
Compare the GeoOp performance with that of Moa Group. Its shares were relatively easy to obtain and a year after listing initial shareholders are showing a loss of almost 40 per cent. In the same period the NZ stockmarket has returned +22.6 per cent. There is an old saying, in the UK, that "you shouldn't take any shares in a new issue you are able to get shares in." Indeed.
Any discussion of the IPO market can't ignore this year's asset sales by the government of Mighty River, Meridian and Air NZ. You would have to say that things haven't gone exactly to plan but these floats have a lot more relevance to Mum and Dad share portfolios than most IPOs because they are large stocks in terms of their market capitalisation, they are profitable and despite their chequered performance we would have to assume that, unlike some IPOs, the vendors aren't selling because they think it is the top of the market. Similarly energy companies aren't flavour of the month, unlike tech stocks.
Besides the debate as to whether these things should be sold or not it is hard to reconcile the objective of "widening and deepening liquidity in the stockmarket" as being something that the government should be concerned with.
One would have thought that was a job for the capitalists. In any case Mum and Dad's view of the stockmarket may not have been greatly improved especially when they look at the losses they have incurred on Mighty River and at least initially with Air NZ. The failure to convert Mum and Dad into long term investors in the stock market was neatly captured by the following comment from an MRP shareholder on the Herald website the other day, "I feel completely let down, if not ripped off ... at the very least I will never support Key and English and will oppose asset sales in strategic areas".
So far the government's strategy probably just gets a C+ but you never know, it is still early days. Finance Minister Bill English alluded to this, and he would certainly have got the prize for the stupidest comment about the stock market that week, when he said words to the effect that people who bought shares in Air NZ in the sell down at $1.65 shouldn't worry that the price had immediately dropped on the stock market to $1.57 because they hadn't lost any money unless they sold. A stockbroking job awaits Mr English in the next life.
Two weeks ago this column was critical of a valuation report by Grant Samuel which said that a bid by Chinese interests for Synlait Farms should be accepted. The Chinese bid valued Synlait Farms at about $48,000 per ha.
Within a few days of the Chinese bid reaching a 90 per cent acceptance level another large Canterbury farm was sold for $25m or the equivalent of $61,000 per ha. I asked Synlait Farms independent directors Barry Brook and Steven Howse if they had any comments on the latest sale at a much higher level than the offer they recommended shareholders accept. Barry Brook didn't reply and Steven Howse said words to the effect that he had no comment. Hmmm.
Brent Sheather thankfully owns no shares in Moa but regretfully none in GeoOp either.
Brent Sheather is an Authorised Financial Adviser. A disclosure statement is available upon request.