What future for underpriced public offerings?

by Financial journal team

Are lowly priced initial public offerings (IPOs) targeted at retail investors good or bad for the stock market?

And what does a strong company in a vibrant industry do, when its share price remains out of tune with its growth trajectory for profits and return on investment?

Those questions assumed greater significance after the Safaricom IPO last year, the biggest ever in the history of the Nairobi Stock Exchange (NSE).

Given the fact that ownership structure in a firm impacts on value, firms in such situations have every reason to feel a little bit peeved that their under priced stock becomes the face of retail investors in the stock market.

In the case of Safaricom, the listing of 10 billion shares for trading on the NSE was itself a bold (some say rash) precedent in a market that was, up to that point, better known for its rather conservative approach to new listings.

Bad card

Since then, many investors remain puzzled by the fact that Safaricom’s history of strong profits is yet to be followed by a boost in its share price, at least to the offer price level. Much of this has, with some justification, been blamed on speculators and the lack of awareness among retail investors, with the general consensus being that Treasury dealt Safaricom a bad card, by insisting that most of the listed shares go to retail rather than institutional investors.

The latter are viewed as having greater expertise and incentive to hold management of listed firms to account, and can do this at lower cost than small investors.They are also great for leveraging capital.

"Demand is still volatile, but with the unprecedented large shareholder numbers, it will take some time before Safaricom share prices stabilise," said King ori Gathinji, Executive Director of Drummond Investment Bank.

Although the prevailing share price, still below the offer price of Sh5, has been determined largely by the supply and demand factors, Kingori acknowledges that the company’s huge stock of retail investors also pose a challenge.

One analyst, who asked not to be quoted because of ongoing business deals with the mobile phone services firm, said the IPO would still have attracted reasonable participation by retail investors, if the offer price was squared off at Sh50, for not more than five billion listed shares.

With time, the cost of transactions weighs heavily on lowly-priced shares: higher priced stocks are more liquid, and have lower transaction costs

Low-priced IPOs

Ironically, it is the return of the much-maligned foreign investors who, with just 15 per cent of the listed shares, have supported the stock recently.

In fact, stockbrokers maintain that for a listed stock that is less than two years old, it may take a while before the market decides the fair price for Safaricom shares.

Kenyan banks are looking at Southern Sudan as the expasion option of choice. Above: KCB Group CEO, Martin Oduor-Otieno, and Equity Group CEO, Dr James Mwangi Photo: courtesy

Incidentally, a study on offer prices and ownership structures for IPOs by the Financial Institutions Centre of Wharton Business School, showed that low-priced IPOs tend to underperform the market in a huge way over a three-year period, unlike high-priced IPOs.

However, while low priced IPOs do attract a significant number of speculators that dilute the share price, not everyone views it as a bad thing.

"Lowly priced IPOs end up attracting many investors in general, based on their investment objectives which could include saving for retirement, speculation and to diversify their investment portfolios. The issuer determines the appropriate price for the shares on offer using different valuation criteria," Capital Markets Authority Chief Executive Stella Kilonzo told Financial Journal.

She adds that the issue revealed "the presence of a huge absorptive capacity within the Kenyan Capital market and a sufficient liquidity and appetite for equity."

She said the number of investors in the stock market happened to have increased to nearly 1.5 million from 800,000 before the IPO.

The prime advantage of going for retail investors is that the company faces less pressure to clamp down on research and development to provoke a short-term price appreciation.

The Wharton study established that higher priced offers attract more institutional investors, who look beyond the short term, to the ability of the firm to anchor strong returns on investment.

So what to do? Some of the alternatives include share consolidation and share buy-back.

"Consolidation is one of the steps to reduce the large number of shares. But if the shareholder register remains large it may not help," said Mr. Peter Wachira, senior Investment manager at AIG Investments.

Wachira believes the best way is to allow the exit of retail investors and leave the Safaricom shares in the hands of institutional investors.

Institutional investors hold shares for long term returns as opposed to small and retail investors who buy shares for short-term gains (speculation).

"It will really help if the Safaricom shareholder register is more of institutional investors," said Wachira. Share consolidation is simply a way of reducing the supply of a company’s shares in the market by taking a pool of shares to represent a single share for example 100 shares owned by a single individual to be equal to one share.

On the other hand analysts contend that the performance of the stock market has generally fallen and the grim performance of most counters has nothing to do with the companies themselves.

Many speculators

Indeed Safaricom share price does not reflect the true fundamentals of the company.

The mobile operator has remained the most profitable company in the East and Central African region, and a market leader in the telecommunication sector.

"I think the Safaricom IPO attracted so many speculators, many of whom have been exiting the market because they did not intend to hold the shares for the longer term," said Wachira.

Stabilising Safaricom’s share price could involve buying back the shares from the market to reduce supply.

"Of course all that will depend on what the firm’s main want," said Justus Agoti, Head of Research at Sterling Investment Bank (SIB).

In addition, there is no law providing for share buy back in Kenya.

"I understand the law does not allow share buy back. If a company has issued the shares there is no provision to buy back unlike in the developed markets," said Wachira.

According to Agoti, Safaricom’s current share price at the NSE reflects the liquidity of the share.

The share closed the week last Friday at Sh3.80 per share. Safaricom has 40 billion ordinary shares, with 10 billion trading at the NSE.