KEY POINTS:
Risk and return are two of the biggest issues faced by investors and this is particularly true for new listings or Initial Public Offerings (IPOs). Most IPOs are risky because the issuing companies are either start-ups or are relatively unknown to the investing public.
IPOs also highlight the
big difference between individual and institutional investors. The former have a much higher propensity for risk while the latter prefer to wait until a company is profitable before they make their initial investment.
These characteristics have been particularly evident in NZ over the past few years.
42 Below, which was the first of the recent start-up IPOs, had 121 million 50c shares on issue when it listed in October 2003. The original investors received 90 million shares for a total cost of just $2 million while the investing public purchased 31 million shares for an aggregate consideration of $15.5 million (see table).
The vodka marketing company had total revenue of only $500,000 for the eleven months ended March 2003 but it was not short of optimism and hype.
Most fund managers didn't participate in the IPO because the company didn't have a proven track record and the float had a strong bias towards the original shareholders as their average cost per share was only 2.2c and they ended up with 74.4 per cent of the shares but contributed only 11.4 per cent of the cash.
42 Below never made a profit but Geoff Ross did a remarkable job of promoting the company and three years after listing Bacardi made a successful takeover offer at 77c a share.
Xero Live, which listed on June 5, has 55 million shares on issue. The original shareholders received 40 million shares, at an average cost of just 7c each while 15 million shares were issued to the public at $1 each.
Investment managers also have minimal shareholdings in this issue because the company is unproven - it had total revenue of just $194,000 for the six months to September 30 - and the difference between the price paid by the original shareholders and the public was too high.
Nevertheless institutions will be watching Xero Live closely to ascertain whether its new web based accounting system is gaining traction amongst small companies.
Chief executive Rod Drury wants to build a successful long term company but he needs to create more publicity so that his competitors feel threatened and are tempted to make a takeover offer.
This strategy proved to be highly successful for Geoff Ross and 42 Below.
Burger Fuel's original plan was to have 60 million shares on issue, with Chris Mason and Josef Roberts holding 22.5 million shares each and 15 million shares issued to the public at $1 each.
It is difficult to work out how much Mason and Roberts, the two original shareholders, paid for their holdings but it looks as if it was no more than $120,200 for their combined 45 million shares.
The uptake for the public offer was disappointing and only 8 million shares, instead of 15 million, were subscribed for. New investors contributed $5.25 million with Mason and Roberts subscribing for the remaining $2.75 million of the public offering.
Mason and Roberts have ended up with 47.75 million shares at an average cost of just 6c each compared with $1 a share paid by the public.
Burger Fuel has gone remarkably quiet since it listed on July 27. This is frustrating as far as Burger Fuel shareholders are concerned because Roberts seems to have the flair and personality to adopt the Ross/42 Below high profile approach.
The latest high risk IPO is Diligent Board Member Services.
Diligent is a US based group that provides software to manage the distribution, accessibility and use of corporate board papers and other important documents in electronic form.
Diligent is listing on the NZX because chief executive Brian Henry is a New Zealander, its software development operation is located in Christchurch, the company has a number of New Zealand clients and the offer is more appropriate, in terms of size, for the NZX.
Under this IPO, which closes next Wednesday, 24 million shares will be issued to the public at $1.00 each. After the listing there will be 104 million shares with 80 million shares being issued to existing holders for an effective consideration of only $3.5 million or less than 5c each.
Diligent, which had net sales of US$789,000 ($1,022,000) for the six months ended June 2006, is planning to use the proceeds from the public issue to fund an aggressive sales and marketing programme. It believes that it has a top class product that will appeal to major corporations throughout the world.
The company is forecasting a US$11 million loss for the December 2008 year and a deficit of US$400,000 for the following year.
The 42 Below, Xero Live, Burger Fuel and Diligent Board Member Services IPOs have been remarkably similar in terms of the large number of shares issued to existing shareholders for relatively little consideration and the non-proven characteristics of the four businesses.
Most investment managers would prefer to wait until there is fairly clear evidence that a business will be successful even if it means buying shares at a premium to the IPO price.
Rakon and Opus International Consultants' shares were keenly sought-after by investment managers because both companies were well established and had positive net earnings forecasts. They were far less risky than start-ups and had attractive growth prospects.
Rakon offered 41.25 million shares to the public at $1.60 each. This was a combination of 35 million existing shares and 6.25 million new shares issued by the company.
The founding Robinson family realised $56m from the IPO compared with its estimated equity contribution of $13.1 million over previous years.
Rakon's promoters and financial advisers underestimated the level of institutional support the company would receive. The stock opened at $2.20 on May 16, 2006, surged past $3.00 on June 7 and achieved a 100 per cent return on the $1.60 a share IPO price a day later. Opus International Consultants was acquired by Opus Plc, a Malaysian based holding company, from Works and Development Services Corporation for $47.8 million in November 1996. Opus Plc sold 22 million shares at the IPO price of $1.65 a share. This reduces its net purchase price for the New Zealand company to $11.6m or just 13c per share.
Institutional support for the Opus issue was strong because the company had a proven track record and attractive growth prospects. This was reflected in its share price, which rose from $1.65 to a high of $2.30 on November 15 although it has eased back since then.
Risk and return are big issues in relation to IPOs and any other investment decision. Individual investors are more likely to be attracted by confident entrepreneurs whereas fund managers are far more conservative and want to see signs a business is going to be successful.
The challenge for individuals is to identify a start-up company that will become profitable and eventually attract institutional investors or a takeover offer.
Geoff Ross and 42 Below have demonstrated that start-up companies can deliver superior investment returns even when they are still operating at a loss.
* Disclosure of interest: Brian Gaynor is an Executive Director of Milford Asset Management.
