IPO & Private placement

INITIAL PUBLIC OFFERING PRIVATE PLACEMENT

(2007

INTRODUCTION

Equity generation plays a significant role in the management of an establishment . Attainment of the required capital for running business enterprises is the life wire that makes such organization to tick and survive . For a sound management and the effective attainment of set objectives and goals for an organization , there need to be the presence of adequate finance and capital layout . The presence of adequate capital need the manpower to effectively utilized the available resources in the organization in meeting those immediate objectives

and targets of the organization . Organization continues to growth in experience and gain market shares when it has a sound strategy in place . Thus , the growth of an organization would reach a stage where it would want to broaden it operational base . In this instance , more capital base is needed , and the organization seeing its level of capital would want to invite the public to partake in the floating stream of capital . Here , the organization tends to float its shares in the stock market . When an organization is going to the stock market for the first time to seek for subscribers to its shares , and be quoted in the stock market , this is referred to as Initial Public Offering (IPO . IPO is used by organization to raise capital for the organization , and thus making the organization a public company (Public Limited or Unlimited Liability Companies , as the case maybe . According to Ritter (1998 , An Initial Public Offering (IPO occurs when a security is sold out to the general public for the first time , with the expectation that a liquid market will develop .An IPO can be of any debt or equity security (Ritter , 1998 . When a company publicly trade its stock , it means it can raise capital through subscribers , by the offering of its shares to be diversified to investors . In addition , this process is regarded as more cost effective than when the company operates as a privately held organization where capital can be raised from restricted few investors . To buttress this point , Ritter (1998 ) has it that , enhanced liquidity allows the company to raise capital on more favourable terms than if it had to compensate investors for the lack of liquidity associated with a privately- held company existing shareholders have the opportunity of reselling the shares in open- market transactions . In the cause of privatizing a public enterprise , a new approach adopts the IPO as a means of enforcing the implementation of privatization . Initial Public Offerings (IPO-PLUS : This is a more recent approach to privatization , which emphasizes on the combination of a case - by- case privatization Advantages of this method are that it generates revenues , gives shareholders control over managers , and provides access to capital and skills (Ijaiya , 1999 :114

Private Placement (PP ) is a method of implementing privatization of public enterprises . It involves the appointment of a private firm to manage the affairs of a public enterprise . The nominated private firm is not the owner of the managed enterprise , but in form of caretaker to see to the effective management of such enterprise . In other words , a management contracts places a public enterprise under private management for a specific period . For the management services , the contractor is paid a fee , which may be based partly on performance . In using Private Placement in sourcing fund , it means that the organization would be restricted in sourcing for fund for few individuals in the public . These shares are not quoted in the stock market , and the company can not declare it shares for the public to subscribe

OBJECTIVES OF THE STUDY

This report tends to meet the following objectives

To give an analytical difference between Initial Public Offering and Private Placement

To show where necessary and significant for implementing IPO or PP in the raising of equity and enforcing managerial reform measures in the organization

To determine the cost risks , time frame , and economic drivers involves in implementing each of the method for equity and managerial control measures

To show the type of companies that embarks on each method of equity sourcing

To recommend best approach for choosing IPO and PP

THEORIES AND MODELS OF IPO

As earlier stated , most research works on IPO had concentrated mostly on issues that have to do with underpricing in IPO . Hence , majority of the available theories and models are structured around underpricing in IPO Some theories of underpricing of IPO are based on asymmetric information . Here , several theoretical models conclude that underpricing results from asymmetric information among groups of agents taking different roles in the IPO process . Underpricing is then an incentive used to stimulate the uninformed group to act in the interest of the informed one (Schindelei Perotti , 2002 . Some of these models based on asymmetric information include the following

Baron (1982 , proposed the principal-agent model . This model looked at the asymmetric information that may exist between a firm and its investment banker . It considers the new issue underpricing based on this type of information asymmetry . The investment bank being an agent of the firm has superior information concerning its value . Hence , his compensation is a function of the proceeds from issue and the post-floatation price . The price discount , therefore , serves to induce the investment banker to put enough effort in advising and selling the firm ' shares . This investment banker 's monopsony power hypothesis according to Ritter (1998 , occurs when investment bankers take advantage of their superior knowledge of the market conditions to underprice offerings , which permits them to expand less marketing effort and ingratiate themselves with buy-side clients . While there is undoubtedly some truth to this , especially with less sophisticated issuers , when investment banking firm go public , they underprice themselves by as much as other IPOs of similar size . But this model has being refuted . Muscarella Vetsuypens (1989 , cited in Scindelei Perotti (2002 , has it that underpricing proved to be significant at IPOs by investment banks as well , even though no asymmetric information existed since issuers acted as their own agents in the going public process

Rock (1985 ) `Winners Curse model ' is another approach to underpricing This model focuses on differential information of investor participating in the IPO market . It is based on information asymmetric between two groups of investors the informed and the uninformed . The informed group knows well the prospects of firms and therefore is able to avoid buying low value IPO shares . While the uninformed people have no information on the firms ' value , which results in a bias in their purchases towards les profitable equity issues . The uninformed investors face a winner 's curse , where they stand a better chance of being allocated shares in overpriced rather than underpriced issues . If the new-issues market is dependent on the participation of uninformed investors undercan only create a successful issues market by purposely underpricing new issues . .Faced with this adverse selection problem , the less informed investor will only submit purchase s if , on average , IPOs are underpriced sufficiently to compensate them for the bias in the allocation of new issues (Ritter , 1998

Signaling theories are other theories of underpricing focus on another type of asymmetric between firms and investors . These theories assume that it is selling entrepreneur who posses superior information about the value of the IPO firm . In to overcome adverse selection companies with favourable prospects are interested to signal their value and thereby convince potential investors to buy shares . Early s on with signaling models in Leland Pyle (1977 , cited in Brau ,et al (2005 ) Schindelei Perotti (2002 , argued that selling insider shares and selling a large portion of the firm in the IPO served as negative signals related to equity retained at initial share issues . Managers of profitable companies intend to convey information about their quality to outsiders : retaining equity might be a signal of high quality

Other signaling models include Welch (1989 , Allen and Faulhaber (1989 and Grimblatt and Hwang (1989 ) models which suggested that firm underprice initially to let investor realize larger proceeds from secondary issues . They have it that pricing initial offerings at a discount is a credible signal of firm quality (cited in Schindelei Perotti , 2002

Other potential signals of IPO pricing and risk include firm age and other size . According to Delbor Sullivan (2005 , this implies that greater uncertainty will accompany an offer by younger firms . Firm age may also proxy for managerial experience , which may be particularly important in an extremely competitive industry

A theoretical model of IPO pricing at privatization is proposed by Perotti (1995 . This explanation suggests that underpricing and equity retention serve the goal of signaling commitment of the selling government to a privatization policy without future redistribution of asset value (Scindele Perotti , 2002

Other models of underpricing include

The market feedback hypothesis : this model according to Ritter (1998 where book building is used investment bankers may underprice IPOs to induce regular investors to reveal information during the pre-selling period , which can then be used to assist in pricing the issue . According to this hypothesis , investment banker compensates investors through underpricing , as a way of inducing regular investors to truthfully reveal their valuations . IPOs for which the offer price is revised upwards will be more underpriced than those for which the offer price is revised downwards (ibid

The Bandwagon hypothesis : The IPO market may be subject to bandwagon effect if potential investors pay attention not only to their own information about a new issue , but also whether other investors are purchasing bandwagon effects may develop . In this case , if an investor sees that no one else wants to buy , he or she may decide not to buy even when there is favourable information . In to prevent this from happening , an issuer may want to underprice an issue to induce the first few potential investors to buy , and induce a bandwagon , or cascade , in which all subsequent investors want to buy irrespective of their own information (ibid

The lawsuit avoidance hypothesis : in this model it is posited that in for the issuing firm to avert law suit for the fear of committing an offence by overpricing its issues , it would decide to underprice it According to Ritter (1998 , since the securities Act of 1933 makes all participants in the offer who sign the prospectus liable for any material omissions , one way of reducing the frequency and severity of future lawsuits is to underprice . Underpricing the IPO seems to be a very costly way of reducing the probability of a future lawsuit

The ownership dispersion hypothesis : In this instance , issuing firms may intentionally underprice their shares in to generate excess demands and so be able to have a large number of small shareholders This disperses ownership will both increase the liquidity of the market for the stock , and make it more difficult for outsiders to challenge management (ibid

The Prospect theory : in this theory it is seen that when issuers are pleasantly surprise with the amount they can raise in the IPO (i .e their newfound personal wealth ) they are not significantly concerned with the underpricing and therefore it exists (Loughran Ritter , 2001 cited in Brau et al 2005

Three theories on phenomenon of underperformance of IPOs are identified by Ritter (1998

The divergence of Opinion hypothesis : the argument here is , investors who are most optimistic about an IPO will be the buyers . If there is a great deal of uncertainty about the value of an IPO the valuations of optimistic investors will be much higher than those of pessimistic investors . As time goes on and more information becomes available , the divergence of opinion between optimistic and pessimistic investors will be narrow , and consequently , the market price will drop

The Impresario hypothesis : This hypothesis argues that the market for IPOs is subject to fades and that investment bankers (the impresarios to create the appearance of excess demand , just as the promoter of a rock concert attempts to make it an `event , underprice IPOs . It is predicted by this hypothesis that companies with the highest initial returns should have the lowest subsequent returns . There is some evidence of this at the long run , but in the first six months , momentum effects seem to dominate

The Windows of Opportunity hypothesis : Due to normal business cycle activity , one would expect to see some variations through time in the volume of IPOs . The windows of opportunity hypothesis predict those firms goes publics in high volume periods are more likely to be overvalued than other IPOs . This has the testable implication that the high-volume periods should be associated with the lowest long-run returns

DIFFERENCE BETWEEN IPO AND PP

The process of financing a company with the required capital investments is seen as part of its financial planning process . There is a need for financial planners to carry out an evaluation of every aspect of the organization 's decision process so as to come up with the best means and approach of raising long-term funds . A paramount aspect to be considered in taking this decision includes the selection of a capable investment banker to help the organization in raising the funds needed for its effective operations . The decision variables the organization needs to direct its focus on should depend on established standards the company can rely on in to identify the most qualified Investment Banker Thus , organizations that are still novice and just entering the stock market to raise capital would usually require the professional backup of investment institutions such as banks . In to safeguard the organization against formidable risks associated with under subscription of declared shares , an organization would usually sell its shares to a financial institution and placed the offer in their control , whereby the intermediary organization would be the one to face the gain or lost associated with such offering

Initial Public Offering is used by business organization to raise additional capital for the first time from the public through the stock market . This is a process of accumulating investors and their investments in the business , thus , increasing the owner of the business On the other hand , Private Placement is a means of divestiture of government management of public enterprises . In this instance government , retain the ownership of the organization , but it is managed by private firms on behave of the government . Private placement in public enterprises is aimed at bringing about efficiency in the management of public enterprises . This is aimed at reducing wastages

Private Placement as a tool for raising equity for a firm differs from IPO in the sense that in IPO the public are made to subscribe to the shares of the firm directly . On the other hand , a firm would appoint another organization to which subscription is made to for its shares This is done as a way of guarantee for the subscription of the organizations public offering . Private placement is thus , a strategy used by organization , especially large-scale organization such as public enterprises , who seek private investors to come invest in the business

One significant difference between private placement and Initial Public Offering is that while organizations embarking on private placement are operating at private capacities with less solid capitalization . Most of them do not have their shares quoted in the stock market , but sought for additional investment from individual in the public and not the public at large . On the Initial Public Offering is the soliciting for public to invest in the shares of an organization that is publicly offering its shares for the first time through the stock market . Furthermore , firm that are not utilizes private placement yet gone public to source for shares . Here , a private organization that wants to raise shares would contact prominent private individuals and ask them to come invest in its business operations . Here , the offer is not quoted in the stock market and certain restrictions are place on the volume of funds that can be raised through private placement . However , the authorized capital of a quoted company is pegged at a figure , but from time to time , the organization can modify and increase the share authorise capital . It is pertinent to state that most private firm uses private placement as a means of raising shares before going public through IPO

CASE STUDY ANALYSIS (SAUDI ARABIA IPO AND PP EXPERIENCE

Saudi Arabia a wealthy Arabian state is made up of many organizations operating mostly in the oil industry . There is huge investment in the industry . Thus , it requires that capitals be sought from the public for these organizations to operate effectively . The Saudi Arabian stock market has experienced low moments of operations in contemporary times This has resulted in many investors in shares to lose and yield low dividends . In addition , discourage many from investing . However , the story is not all bad . The stock market has assisted many firms in the IPO operations . Ghalayini said that between February 20 and October 7 this year - a period of nine months , there has been as many IPOs with a "javascript :doCorpInfoSearch 'Emaar " Emaar was by far the biggest with a value of SR679 .9 million . According to Taher , the future expected IPOs for the current joint stock companies are estimated around SR15 billion for 48 companies (MENAFIN .com , 2000

It is germane that some companies in Saudi Arabia who have utilized IPO in raising capital are seen and compared with those who made use of private placement

Mullak United Arabian Company , popularly called `Mullak is a licensed mortgage provider in the Saudi Arabian Kingdom . In the organization 's bid to raise capital via the IPO , it sought the financial advice of Siraj Capital . Siraj capital carried out its strategic financial advice to Mullak by appointing its member to the Board of Director of the organization . Here , strategic decisions are to be collaborative approach to carry out the Mullak financial plans . The Mullak approach and relationship with Siraj , is that of appointing the organization as an intermediary to directly take up the raising of the capital on behalf of Mullak . Siraj runs its investment financial consultation through its subsidiary firm , SMHC which is a Cayman Islands investment vehicle , that is used to give international and smaller investor acquires an invest in shares from SMHC that would mirror the shares of Mullak . Set to benefit from its key role in Saudi Arabia 's rapidly expanding housing market this is driven by one of the world fastest growing populations and lowest levels of home ownership (22 ) Mullak is planning an IPO within two years . SMHC investors will receive shares which are equivalent to Mullak shares and all benefits will pass through to the SMHC shareholders (Siraj Capital Ltd , 2006

Turquoise International is another financial consultative organization that has assisted many Saudi Arabian organizations in raising long-term funds through IPO and PP . For instance , the Gulf Advanced Chemical Industries Company (GACIC ) was advised by the Turquoise International in raising 380m on the project financing of its butanediol facility . Saudi International Petrochemical Company (Sipchem ) was also assisted by the financial consultant in raising capital to the tune of 700m this was based on a joint venture and financing issues relating to the Sipchem acetyls complex (Turquoise International , 2006 . The Turquoise International also assists company to raise IPO . For the cited Saudi Arabian firms , GACIC and Sipchem their funds raised by Turquoise International may not be termed as IPO , but capital sourcing through private placement and other financial institutions

Instances of firms that have carried out private placement in raising capital , through Consulting Center for Finance and Investment (CCFI includes the following

Al-Zamil , Saudi International Petrochemical Co : CCFI placed SR 500 million for this company in GCC countries

Arab Banking Corporation , Bahrain : Together with Credit Suisse First Boston , CCFI was the global Coordinator for this first initial public offering in the Arab World . CCFI was also the Regional Manager for the Arab region offering . In this capacity , it coordinated the placement efforts of nineteen financial institutions in ten different Arab countries

Saudi Cable Company : Together with Saudi International Bank , CCFI handled the private placement of shares of this large private sector company . Placement was made in all the GCC countries

Invest Corp Bahrain : Placement of shares in the Saudi Market

Source : GCC Market report (2007

The table above gives some data based on Saudi Arabia 's stock market trade on IPO of organizations in different industry

ECONOMIC DRIVER FOR IPO AND PP

The economic driver for Initial Public Offering has to do with the wide spread of investment that is enabling through the process . It encourages the public to invest in new field and company that they finds profitable . In addition , the company stands the chance of dividing its capital units into several millions , sometimes billions units that the public would subscribe to , therefore giving it a stream of investors IPO encourages the growth and diversification of investments . Here , an organization that which to diversify its operation would buy shares from a firm that operates in the area of its interest . Through IPO , an organization tends to grow to maturity stage , whereby it would have the required capital base to operate effectively

On the other hand , Private Placement is economically driven with the need to make few investors , especially those wealthy individual to invest excess of their funds in private organizations . Here , the share ownership is not widely spread but restricted

CONCLUSION / RECOMMENDATION

Initial Public Offering is a good way of raising capital especially if the firm seeks to expand its operational base . It is thus , a way of spreading the business risk associated with a firm operational areas to different investors who bears little amount of the risks shared among other shareholders . Firms seeking to carry out an IPO need the expertise of consultant and financial institutions such as banks to aid the process . The expertise requirement and the huge financial involvement for raising funds through the stock market would make the process not to be one that small-scale business should embark on . It requires that a matured and capital consolidated company can go public through IPO Therefore , Private Placement is a better way of sourcing for additional fund by organization , which are still young and trying to grow , expand and consolidate on its operations . In other words , IPO would be a good source for sourcing long term fund for organization that are matured and capital consolidated , while private placement is an alternative open for those organization still trying to get on their feet

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