The art of going public

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MARY JADE T. DIVINAGRACIA

MARY JADE T. DIVINAGRACIA

Globally, the year 2016 may be characterized by fewer initial public offerings (IPOs) by companies. In the Philippines, the IPO market peaked with 12 listings in 2007 before the global financial crisis struck in 2008. There were only two IPOs that occurred from 2008 to 2009 before they averaged four to five annually.

This year, while there have only been three IPOs thus far, the average issue has increased from P4.3 billion from 2006 to 2015 to a whopping P14 billion this year. So while there have been fewer issuances, these have been getting bigger.

There are many reasons why companies go public. Before deciding to do an IPO, it will bode well for the shareholders to examine their objectives. Is the IPO going to be used in raising capital to fund future expansion and growth, or is it for succession and estate planning? Are the current shareholders looking to cash in? Let us examine some of the more common reasons, to assess whether going public will make sense for your company.

Fund raising

Companies often issue shares to the public to raise capital. Business owners believe that by conducting an IPO, one can raise significant capital that can then be used to develop new products and services, increase capacity, expand to new markets or acquire new businesses.

If this is the primary objective, it will be prudent for the shareholders to assess if there are other alternative forms of financing that will likewise address the objective but will not require as much preparation.

A private placement with a strategic investor will meet the fund-raising objective and at the same time provide opportunities to work with a party that will bring in added value, such as new markets, management strength and expanded network, to name a few. This should be evaluated in light of a possible sharing of management control, unlike in an IPO where most investors will take minority position and will, therefore, not have active management intervention.

Another option is to obtain debt financing, instead of issuing equity shares. The Philippine banking system has sufficient liquidity and interest rates are still quite low. Debt is usually cheaper than equity funding as interest charges are likewise tax deductible. The company then has to evaluate whether its financial position will allow it to take in more debt and its impact on the company’s cost of capital.

Access to debt and equity markets

Public companies have easier access to equity and debt markets. It can have follow-on offerings if additional capital is required to fund future plans. Unlike the IPO, follow-on offerings will require much less preparation and lower friction costs.

The growth capital raised during the IPO would have also strengthened the company’s balance sheet. This, coupled with the perceived improvement in corporate governance and transparency as a public entity, makes it easier to raise debt financing.

Liquidity/exit

An IPO provides the company’s shareholders the opportunity to liquidate their shareholdings. However, unlike a private placement, where you can decide to fully exit the business, an IPO will have to be done in tranches due to lockup requirements. Being publicly listed does allow shareholders the platform to liquidate their ownership sometime in the future, with much lower transaction costs.

The desire of the business owners to cash in, particularly during an IPO, should be managed as investors also get turned off if a significant portion of the funds raised in an IPO will go to the pockets of existing shareholders instead of funding future growth of the business.

Currency for future acquisitions

Given the ready valuation for publicly listed shares and assuming sufficient liquidity, public companies can also use their shares to acquire other businesses. This allows companies to expand faster without draining its stash of cash or incurring more debt.

If, after this introspection, the shareholders still decide to launch an IPO, we suggest looking at the following aspects to assess the readiness of the organization to go public:

Financial performance and strong track record

Aside from this being a requirement of the Philippine Stock Exchange, studies show that companies that performed well and were profitable before going public are more successful. Companies who had weak financial performance before their IPO are more likely to drop out of the exchange.

Investors will be attracted to put money in companies that have proven business models and only need capital boost to grow. Track record provides evidence of management being able to deliver on the strategy and add value to the business.

Financial reporting

Public companies have to comply with rigorous financial reporting under the rules of the stock exchange. Before doing an IPO, the company has to evaluate its readiness to provide financial information to management, investors and all stakeholders on a timely basis. The financial reporting system should be reliable, not prone to material errors and should be due-diligence ready.

Human resource and culture

The quality of management is very important since in an IPO, investors are betting on management to grow their investments. As most investors will take minority position, they will not play an active part in managing the day-to-day operations of the investee company.

HR policies and the rewards system should likewise be aligned with the company’s overall strategic ambitions. Running a public company will be different in many ways, so the key management team should have the right behavior and culture to adapt to change.

Governance

Good governance is critical to a company that is looking to have an IPO. It gives comfort to investors that the company is led by a professional team and a well-functioning board, working together to safeguard the interest of all stakeholders. The pressure to consistently show great results can lead to a short-term mindset for managers at the expense of the company’s long-term goals. Without the appropriate check and balance, this may lead to questionable practices. This risk is further magnified if compensation is linked to movement in the company’s share price, possibly leading management to perform somewhat questionable practices in order to boost earnings.

Governance extends beyond the IPO. Even if the company decides not to push ahead with its plans to list, practicing good governance will result in significant benefits to the company, including improved credit rating, reduced risk, better access to credit and higher valuation in the case of a strategic sale. It also prepares the company for succession.

Investor intelligence, communication and external reporting

A huge part of being in the public eye is managing the perception of the investing public, as well as those that may influence their decisions like analysts, security brokers and investment advisors. While a private corporation can keep its business affairs to itself, a public corporation must comply with regular reporting and disclosure requirements including major business decisions, long-term commitments entered into as well as compensation of key management.

The company aiming to go public must also understand its target investor base, their needs and information requirements. A good and effective communication strategy should be in place to manage investor confidence and public trust long after the IPO.

Taxation and corporate structure

Prior to going public, the company should assess whether or not its tax structure is optimized for IPO and life as a public company. Tax strategy and tax planning should be first in the agenda to avoid any leakages as a result of going public.

Resolving tax issues as early as possible will reduce tax risks, which might impact not just the valuation of shares but the appetite of more conservative investors.

Yet, the IPO is not the end goal. Rather, it only sets the stage to help companies grow faster and achieve their strategic objectives. We’ve seen companies that failed after a successful IPO because the founders lost focus, were not able to follow through their business plan, and the reasons why they went public in the first place. These companies are examples of wasted opportunity.

Are you ready to go public?

While going public can have its benefits, it is not for everybody. One has to look at its long-term objectives and assess whether an IPO is the way to go or there are alternative and better ways of getting there. It is a major decision and should be carefully considered. Getting a financial advisor to assess the pros and cons of various alternatives may be expensive but it may help the company avoid an even costlier decision. Going public is like the “coming of age” for a person. You can only do it once so it is extremely important to do it right.

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Mary Jade T. Roxas-Divinagracia, CFA is the Deals and Corporate Finance Managing Partner of Isla Lipana& Co./PwC Philippines. Email your comments and questions to markets@ph.pwc.com. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.

MARY JADE T. DIVINAGRACIA

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