Study of Initial Public Offerings in Saudi Arabia
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This research focuses and does a relative comparison of initial public offerings (IPOs), their motivation and pricing within Saudi Arabia and the United Kingdom (UK). It looks at their respective trading bourses or stock exchange markets and the process companies go through in order get publicly listed on these trading bourses and in an attempt to raise capital from the public. The paper also addresses the economic dimension of IPOs within the respective countries, and its impact on the companies that do decide to issue and go through an initial public offering (IPO). The overall approach used to accomplish the research involves a comparative study of initial public offering (IPO) processes, the motivation of going public for companies in both Saudi Arabia and the United Kingdom, and the pricing structures for the initial public offering (IPO). Needed information or data involves a look at both countries' regulatory bodies, in this case the capital markets authority (CMA), from which much needed information on trading processes is be inferred from, as well as looked at. The use of questionnaires to top management of selected firms is used to give an insight into the motivations for private firms desiring to do an initial public offering (IPO). It becomes clear at the end of the study that the motivation for going public remains primarily the same across both countries, the only difference being within their regulatory bodies and requirements for doing so.
Background of the Study
During the last two decades, initial public offerings (IPOs) have seen a dynamic expansion in markets around the world. A literature search indicated that substantial research has been done on this topic and it has attracted policy makers' attention. In addition, the IPO market has proved to involve potential uncertainty and risk due to the large amount of money invested (Ritter, 2002).
'Initial public offerings of stocks are the foremost important channel of new capital flow to young companies' (Gregoriou, 2006). It is also defined by (Draho, 2004) as 'An IPO is the first time that the shares in a company are sold to public investors and subsequently traded on the stock market'. Going public process is a stage when a company sells shares traded equity for the first time. For a private firm to enter the IPO, it needs an established business plan to indicate to stakeholders of the goals in which the firm will be working towards. Moreover, IPOs is a way to increase liquidity of the company that need for growth through the sale of company's owners shares to investors who believe that the company has a successful future.
Going public process is preceded by the most vital process which is valuation and the principle behind this process is to justify the price of the shares which are offered to the public. Evaluation process is essential for the company to consider its value in comparison with other firms in the stock market.
Moreover, it tells the company the highest price should be offered, and it will inform the buyer that the lowest price should be pay. The company should have a skilled team management, qualified accountants and underwriters to satisfy the requirements of going public and to identify the future aims and strategy after going public. (Stanley, 2005).
Thereafter, other stage should take place known as 'Due Diligence' in order to ensure that there is no opportunity for uncertain information. This stage includes advertisements which taken out in newspapers must present the entire company prospectus. The going-public process will also include a group of banks and brokers, as mentioned, to establish a price per share and the proposal must be admitted to the official list by the listing authority in the issuing country. After this is accomplished, an underwriting period allows shareholders to sell their shares to the public at the issue price; this period varies from company to company depending on company goals. It is obvious that this procedure requires time and money however; it is worth if considering long term benefits (Geddes, 2003).
With regard to motivations, this study will cover the most common to give a better understanding of the advantages. Several factors are considered by decision makers to encourage companies to go public, including the chance to increase shareholders' wealth by expanding operations, to enhance the companies' reputation and prestige, create better organization by attraction of employees. Going public promotes a firm's acquisition value and boosts customer confidence. In addition, an IPO is an easy way to finance a firm and to diversify its operations (Benton, 2005).Rousseau and Wachtel (2002) argued that the stock market provides a developed mechanism to improve the economy and raise growth rate due to liquidity exist to investors which can be used in new projects.
However, financial factors are still the most important considerations in going public (Madura, 1998). IPOs are attractive and occur more regularly when other investment opportunities are not as attractive as these offerings, but as with any decision, going public has disadvantages as well as advantages. If a company's shares are traded on the stock market, it will lead to a change in ownership structure as well as a loss of control by principals; therefore, the decision making will be shared(Albarak,2005)
Regarding an IPO in Saudi Arabia, transformation of enterprises companies in the kingdom to the join -stock ones is not a new experience, but the number of joint- stock companies was very little.In 1984, a decision was decree to start trading shares through local banks. In the same year, it was formation of a ministerial committee to oversee the market. Saudi Monetary Agency took over control and supervision of the market operations in 1985. 1990 it was the year of introducing the first electronic system for trading shares in Saudi Arabia. In 2001, was launched (Tadawel) trading system, add modern techniques and characteristics to keep pace with developments in the world. Financial market environment has been developed; rules and the issuance of new regulations were established. As a result of these developments Capital Market Authority was established in 2003 according to the latest standards and foundations. The combination of stock market and oil prices, has given a strong boost to the Saudi market.
CHAPTER TWO: LITERATURE REVIEW
This chapter tends to expound on the comparison between the initial public offering (IPO) process, pricing, and the IPO implication to firms in Saudi Arabia and in the United Kingdom (UK). Several researches have been undertaken throughout the world, discussing IPO processes and its impacts on economies and businesses. Most of these previous researches have been pursued by considering a specific country; have but lacked effective comparisons with other economies. In this study, the extra mile is achieved by selecting two entirely different economies, in terms of IPO processes and financial regulations. Discussion on early researches have been made along with the effective exploration and comparison of the existing IPO process, its implications and pricing issuesâ€”considering Saudi Arabian and UK economy.
'Initial public offerings of stocks are the foremost important channel of new capital flow to young companies' (Gregoriou, 2006). It is also defined by (Draho, 2004) as 'the first time that the shares in a company are sold to public investors and subsequently traded on the stock market'. The going public process is a stage in which a company sells shares to the general public and traded as equity on a trading bourse for the first time. For a private firm to enter the IPO, it needs an established business plan to indicate to stakeholders of the goals in which the firm will be working towards. Moreover, IPOs are a way to increase liquidity of the company that need for growth through the sale of company's owners shares to investors who believe that the company has a successful future.
2.2 Initial Public Offerings (IPOs)
When a private company undertakes to 'go public' via divestment of its private equity or stock, it is said to be getting into an initial public offering (IPO). The two main reasons most firms go public include acquisition of additional capital to finance growth or the raising of finances to pay off debt. Since initial public offerings (IPOs) denote the public trading of a firm's shares, it has long been documented by various literatures that many first-day trading is usually abnormal. Huge price gains are the norm in IPOs between the offer price and the closing price by the end of trading on day one. This difference in the gain in prices is rarely justifiable since the main aim of IPOs is to raise money for the company, yet as seen, money is left on the table in most instances that the company could have gained from. Academic scholars and financial experts continue to research and look into this anomaly that has continued to baffle the industry (Ritter & Welch, 2002).
2.2.1 The IPO Process in Many Countries
For many countries globally, the steps of going public are pretty much the same. The regulatory body in each country is usually the Securities and Exchange Commission (SEC), whose main role becomes a security agent in the prevention of fraud and in the protection of investor interest.
Most IPOs begin with the selection of the investment bank(s) who serve as the company's underwriters. As an underwriter, the bank purchases shares from the company and sells them to the general public on behalf of the company. Due to the legal complexity IPOs can impose, attorneys are used to aid through the entire setup process. In certain instances, some firms opt to sell their shares directly to the public, but this is seldom the case.
Registration statements are then prepared and submitted to the SEC. The statement contains reports of the company's fiscal health as well as the business plan during and after the IPO. Since the SEC is the regulatory body, it scans these statements and carries out its due diligence on the bank to ensure that it is in compliance with all rules and regulations needed to carry out an IPO.
After finalizing with registration statements and while still waiting for SEC approval, a company needs to prepare what is known as a preliminary 'red herring' prospectus. This is prepared with aid from the firm's underwriters. The prospectus details the company's financial records, plans for the future, as well as specifications of what the price for the floated shares will be. This prospectus is primarily used by potential investors seeking more detailed information on a firm prior to buying shares and has a legal warning preceding the IPO as it awaits SEC approval.
Completion of the prospectus gives way to a 'roadshow' in which both underwriters and company officials visit various trading hubs within the country and promote the IPO. In other countries, this information is given to the public via gazette notices, broadcast announcements and distribution of prospectuses. The aim of this is to give potential investors as much information as possible regarding the company and attain feedback in relation to what potential investors feel about the whole process.
Once the SEC has gone through the prospectus and given information and is satisfied all regulations and requirements have been heeded, it gives a nod for the proceeding of the IPO. Amendments are made by the company if the SEC still needs corrections to be made prior to their approval. In countries which have more than one stock exchange, the company must choose the exchange where its intended floated shares are to be sold and listed against.
Arguably the most complex of all decisions in an IPO process is the decision on the price the floated shares will be sold at and how many of the same should be issued to the public. This is done with consultation with the company's underwriters. The underwriters buy huge stakes of the company's shares for sale to the market. Huge investors are also at times given the privilege to buy the same shares a day prior to listing the shares on the stock market. In countries like the US where the general public gets to buy shares in the secondary market and in which the company does not really gain from the sale at this point, the IPO process concludes for the company after underwriters and huge investors have bought the company's shares. In other countries, the general public is permitted to acquire shares from the primary market directly through stock brokers who deal directly for the company.
2.2.2 Initial Public Offering (IPO) Pricing and key Influencers/Players
Traditionally, the IPO pricing was done by agreeing upon and fixing an 'issue price' based on the capital they were trying to raise. This price was agreed upon by the company and the merchant banker. The general public was simply left with the obligation of looking at the price offered and deciding whether or not they would fill in an application form at the given price and subscribe to the issue. Researchers worldwide have arguably revealed that this method is the single largest reason for IPO under pricing (Stanley, 2005). Many IPOs are known to under price the value of a company's shares by as much as fifty percent. Said and done, neither the company nor the investment banker really ever knows the real price of the company's shares. Ironically, the answer to how much a share should be sold for falls at the discretion of the buyers since they are the ones who predetermine at the open of trading how much they are willing to pay for a share of stock. This is what can be described as 'the hallmark of a healthy IPO market' (Shah, 1999). While this is not a realistically possible way to determine what price to sell the stock at, the underwriter looks at elements such as the value of the firm and compare it with that of similar firms, how much capital is needed from the IPO, conducts preliminary research to find out how receptive the market may be, and finally, sets upon the final decision on the price that should be floated to the general public for sale. Easy at it sounds, setting the IPO price is a very delicate and sensitive procedure that takes the effort of many stakeholders and combined calculations from accountants (Draho, 2004).
Undeniably, the most important player during the IPO process is the underwriter. The underwriter in many instances is also the investment banker and his primary importance becomes that he has the appropriate distribution channels and contacts necessary for the company's shares. The underwriter also assists in determining the price of the IPO and creating enthusiasm for its listing (Geddes, 2003). The other key players include those involved in the IPO process like the SEC who are in charge of ensuring correct practices are adhered to, and last but not least the private equity company itself. The latter is extremely vital in the process as they have all insider information of the newly-to-be-listed company and any action from them can trigger a response within the trading bourse at the stock exchange.
2.3 Initial Public Offering (IPO) Process in Saudi Arabia
In comparison with other developed stock exchange markets, the Saudi Stock Market (SSM) is much newer and classified as an emerging market within the Middle East and North African region. According to Al-Barrak (2005, p.32), there is no explicit list of documented IPO cases in Saudi Arabia and of all the listed companies on the SSM, 'just ten IPO cases occurred in Saudi Arabia from 1988 until 2004'.
In Saudi Arabia, companies, by law adopt the book-building process to go public. CMA handles all the application process and takes the decision on whether a company can go public or not. Eighty-five investment companies in Saudi Arabia took part in the book building process in 2009. According to the CMA, fraudulent activities can be handled beforehand, and this process ensures transparency, fairness, and equality in the system (Capital Market Authority (CMA), 2009, p 29). Oil revenues have provided great liquidity in the process of introducing new IPOs in Saudi Arabia. Investment banking in Saudi Arabia was still in its infancy until 2004, and very few firms had gone through an IPO (Al-Barrak, 2005).
2.3.1 Capital Markets Authority (CMA) Evaluation of IPOs
The CMA binds firms and makes those requesting to have an IPO or seeking permission to get involved in other investment activities adhere and meet all legal, operational and financial regulations. In the process, companies are required to convince the CMA that the financial activity the company intends to get into or start is proper. Firms are also supposed to provide the evidence of all required financial and managerial expertise for any said financial undertaking (Ritter, 2002).
2.3.2 Future Developments
Improvements are underway in the IPO and financial regulation process. Many private and family-owned businesses are thinking of going public due to the provision of an exit route through IPO. Regulations regarding any take-over by a company have also been laid out in an attempt to avoid hostile takeovers, and in ensuring fairness and transparency in the process. Other encouraging steps taken by the CMA have been in the defining and writing down of the listing rules, information and disclosures investors can get. These regulations, though not a quantum leap toward an ideal financial market, certainly boosted investors' morale. Investors showed confidence, and Saudi Telecom experienced over 900,000 subscribers. Al-Hilad performance was amazing as the bank raised SR9 million of excess capital in 2005 [i] .
2.4 Initial Public Offering (IPO) Process in the United Kingdom (UK)
Within the United Kingdom (UK), there has been only one IPO between 1980 and 2003. The reason for this slow pace was deepened in the poor regulatory frameworks, and dual processes for having a conversion from a Limited Liability Company to publicly listing one. A strong regulatory framework could act as an incentive to the merger or listing, but such benefits have not been found within the UK in the IPO process (Ritter & Welch, 2002).
2.4.1 Due Diligence
To make sure that the company going public meets all necessary requirements, it is required by UK law that the company's accountants and legal advisors provide a comprehensive written report after reviewing the company from a complete legal, financial, and commercial perspective. In some cases like real estate where valuation matters a lot, the concerned investment banks are also required to submit a detailed due diligence report about valuation (Draho, 2004).
2.4.2 Pre-Initial Public Offering (IPO) Research
Prior to starting any IPO promotion activity, the investment bank's research analyst is responsible to make a research note on the company. This research note is issued two days prior to the IPO launch. Pre IPO law helps to educate and protect investors by providing the impartial review of the company's valuation. The research analyst provides the financial projections with their own perspective about company; which illustrated an element of impartiality in the entire process. This research also becomes a marketing tool and automatically sets market expectations regarding the company. The research note is written in light of the available company's data (Rousseau & Wachtel, 2000).
2.4.3. Investor Presentation of IPO
After completing all the pre-IPO requirements, presentations are used by management to promote the company's IPO. This process continues until three weeks prior of the listing. The sales team of the involved investment bank provides all the information needed by investors, and follows up the potential buyers. As investors have the option of submitting orders with their prices, the receiving or investment bank gets an idea about average price of a share that investors are willing and able to pay. While choosing the investors, companies prefer institutional investors due to long-term commitment they show. This is contrary to hedge funds which can affect a share price for short-term gains (Draho, 2004).
2.4.4 Disclosure Document
The preparation of the company's prospectus is highly important for an advisor, as it can be used as a marketing tool to attract investors and for meeting the disclosure requirements of AMI and the prospectus rules for the listing companies.
2.4.5 Underwriting Agreement
Within the underwriting agreement, two types of negotiations are involved: The first is between a company, its shareholders, and its respective legal advisors. The second is between an investment bank and its legal advisors. Involvement of a private equity investor is highly desired in the process (Benton, 2005).
2.4.6 Post Initial Public Offering (IPO) Requirement
After a company registered as a listed company, both the investors and the board must follow the UK law, and operate the company's affairs within the stipulated UK regulatory regime. Adherence according to the financial services and market act of 2000 stipulates that insider trading laws, disclosure, and transparency rules must be ensured, as well.
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