When the stockmarket is buoyant you can expect a spate of new companies coming to the market – achieving a listing or quote for their shares for the first time – encouraged by the high valuation that will be put on their shares and by investors’ readiness to buy them. The term ‘new companies’ is perhaps misleading. They are not usually new businesses, but businesses which are new to the stockmarket. For the first time their shares can be bought and sold on the stockmarket. The larger ones may apply for a listing on the London Stock Exchange itself (the main market, which used to be known as the official list). Smaller or younger companies (or companies which wish to float only a small amount of their share capital) may apply for a quote on the Alternative Investment Market or AIM, which is also run by the LSE.
The rule used to be (and still generally is) that a company needs at least a three-year trading record before it can list on the main market. But times are changing. While it may take many years to build up a business in traditional manufacturing areas, Internet-based businesses can – and often do – have a much shorter gestation period. The Freeserve free Internet-access provider, established as a spin-off from the Dixons high street electrical and electronics retailing chain, was allowed to launch in its own right on the main market in 1999 when it had been operating for well under a year. It was valued at over £1.5 billion at the issue price, without at that time ever having made a profit. Freeserve may have been an exception at the time, but later in 1999 the London Stock Exchange announced the formation of a ‘market within a market’ called techMARK, to recognize the particular characteristics and needs of technology companies. Though techMARK is part of the main market, changes were proposed to the listing rules that would allow techMARK companies to join the market without the normal three-year trading record provided they satisfied certain other criteria. Some young companies in the technology area, which up to then had qualified only for an AIM quotation, were expected to move up to the main market as a result.
For many individual investors, applying for shares in new issues was their first introduction to stock exchange affairs. They may have applied for shares with the intention of holding onto them as an investment. But they may also have stagged new issues by applying for shares in the hope that these could be sold at a profit as soon as dealings began (we will see later why this was often a good bet). But there have been changes here, too. The number of new issues which are thrown open for subscription by the public at large has declined drastically in recent years. With the major privatization issues now out of the way, the most likely route for many private investors to have acquired shares for the first time has been through the launch of former mutual building and insurance societies.
The Internet is a natural medium for making information available to large numbers of people and the opportunities it offers for marketing shares have not been overlooked. But be a little careful. The international nature of the Internet also makes it an ideal medium for those attempting to promote shares in duff businesses that do not conform to the listing requirements of any reputable stock exchange.
However, if properly used the Internet could improve access to new share issues for the general public. Reputable on-line brokers and banks may have allocations of shares that are available for subscription by their clients.
The Internet has impinged on the new issue scene in another way, as the Freeserve example suggested. The run-up to the millennium saw a spate of new issues – mainly on the AIM market – of companies engaged in one type of Internet business or another. The inclusion of ‘.net’ or ‘.com’ in the company title seemed enough to secure a market capitalization of many millions of pounds for businesses which had never done anything as prosaic as earning a profit. Like most stockmarket fashions, the enthusiasm for the so-called dotcom companies showed every sign of running out of control. Investors tended to forget that the very nature of the Internet, which allows a novel idea to be exploited with startling rapidity, also allows competitors or imitators to join in and erode the position of the innovator equally fast. Trouble was widely predicted at the turn of the millennium, and seemed more than likely.
First, the mechanics of a new issue.
There are four main ways a company may float its shares on the market. (Flotations have traditionally attracted nautical metaphors just as takeovers attract marital ones, and a new issue may also be described as a launch. It is perhaps a pity that the more prosaic American term Initial Public Offering or IPO is now gaining ground). These launch methods are:
• The offer for sale. Shares are offered for sale to the public, partly via the medium of the newspapers which carry details of the issue. A full prospectus giving a great deal of information on the company, its financial position, its trading record and its directors and advisers is a legal requirement when shares are marketed, though it may be only an abbreviated mini-prospectus that appears in the press with details of where to get the full document. The offer for sale, though less common nowadays, is the method of most interest to the general public and we will look at it in detail later.
• The placing. In this case the company achieves an initial spread of shareholders by arranging privately to sell shares to a range of investors: usually several hundred of them. The placing is usually arranged by the company’s broker and most of the shares will probably be placed with his clients. The general public who are not clients probably do not get a look-in at this stage. After the placing, permission is given for the shares to be traded on the stockmarket, and anybody can buy in the normal way, though the price has probably now risen above the placing price.
• The intermediaries offer. Shares are offered for sale to financial intermediaries for allocation to their clients. Again, investors who are not clients of the intermediaries in question cannot buy at this stage but have to wait until the shares are traded on the market.
• The introduction. An introduction is likely to be used when a company already has a large spread of shareholders and simply wants permission for the shares to be dealt in on the stockmarket. An introduction does not involve the raising of capital or the marketing of shares – though it could pave the way for raising additional capital in the future – and it is the cheapest way of coming to market. When a company moves up from the AIM market to the main market or when a former building society distributes shares to its members and seeks a listing, it will probably be by way of an introduction.
With the exception of introductions, combinations of these various issue methods may be possible.
In any report of an offer for sale, a placing or an intermediaries offer, one of the first points to focus on is: who gets the money from the sale of the shares? The shares may come from one of two sources:
• shares being sold by the existing shareholders – perhaps the founders of the company who built it up from its inception. In this case the cash raised goes to these original shareholders, not to the company;
• new shares created by the company. In this case the cash from the sale of the shares goes into the company’s own coffers, not to its original owners.
In practice, the shares made available may be a mix. Some are existing shares sold by the owners and some are new shares sold to raise cash for the company. Be a little cautious if you see that all the shares are coming from existing shareholders and that they are disposing of a large part of their holdings. Why have they decided to cash in at this point? There may be a valid reason, but you would want to know.
Offers for sale to the public are of two main types: fixed-price offers and tender offers. The fixed price offer is the more common. How is the price fixed?
Every issue requires sponsors. Traditionally, an issue would be sponsored by a broker or both an investment bank and broker might be involved. More recently, other types of institution – such as accountants – may apply for permission to act as sponsors. And on the AIM market the role of nominated adviser is substituted for that of sponsor. Normally – though not always – a company coming to market makes in its prospectus a forecast of profits and dividend for the current year, as well as giving details of its historical profits. Working with these figures, the sponsors will look for existing quoted companies in a similar line of business. By reference to the ratings (PE ratio and yield) that these companies enjoy – and adjusting for the superior or inferior growth prospects of the new-comer – it should be possible to fix the appropriate rating, and therefore the price, for the shares of the newcomer. Much the same pricing process is at work whatever issue method is used. In the case of larger issues, the advisers to the company may also sound out major investors as to how many shares they would be prepared to take at what price – a process known as bookbuilding (see glossary).
Two points should be borne in mind. The sponsors want to make sure the new issue gets off to a good start: in other words, when trading begins in the shares the price in this aftermarket should not be below the offer for sale price and preferably should rise some way above it. So they will try to pitch the shares at a price a little below what they are likely to be worth. Too far below and they will be accused of failing to get a sufficiently good price for their client. The dotcom companies that were launching in profusion around the turn of the millennium were a bit of an exception. In many cases shares shot way above the issue price in first dealings – but there was no rational way of valuing them anyway.
Second, the company itself almost certainly errs on the side of caution in arriving at its profits forecast. There is nothing worse for a market newcomer than to fail to meet its prospectus forecast. So the forecast will be pitched some way below what the directors expect profits to be.
The first point means that – unless the sponsors have got their calculations badly wrong or the stockmarket drops sharply between the price being fixed and the start of dealings – the shares are being sold at less than their likely value and there is therefore a very good chance of a quick profit for stags who manage to secure an allocation of shares. The second means that you should not take too seriously the reports that appear later when the company publishes its first profit figures after going public. They are often headed something like ‘XYZ Holdings exceeds forecast’ as if this implied unexpectedly good performance. The truth in most cases is that investors should have been worried if the company did not exceeed its forecast. It had planned to do so.
Some companies are almost impossible to value – for example, there may be no comparable quoted company – and in these circumstances a tender offer can make sense. Investors are invited to apply for the number of shares they want and asked to state what price they are prepared to pay above a stipulated minimum. Assuming the issue is fully subscribed – applications are received for at least the total number of shares on offer – the sponsors will calculate at what price all the shares available can be sold. This becomes the striking price and anybody who applied for shares at this price or above has a chance of getting some. The shares are often allocated at the striking price, even to those who bid at a higher price, though sometimes applicants are required to pay the price that they bid instead. Those who bid below the striking price get no shares.
The striking price will not always be the highest possible price at which all the available shares can be sold. As this becomes a bit complicated, an example helps. Suppose XYZ Holdings offered 10 million shares to the public and invited tenders at a price of 120p or above. Applications were received as shown in Table 8.1:
No. of shares applied for at each price |
Price |
Cumulative total of shares that could be sold at each price |
2,000,000 |
140p |
2,000,000 |
3,000,000 |
135p |
5,000,000 |
5,000,000 |
130p |
10,000,000 |
2,000,000 |
125p |
12,000,000 |
4,000,000 |
120p |
16,000,000 |
Table 8.1
The right-hand column shows that, at a price of 130p, all of the 10 million shares available could be sold, since there were applications for 5 million at 130p, 3 million at 135p and 2 million at 140p. So 130p would be the highest possible striking price. But the sponsors may decide they would rather sell at a slightly lower price to ensure the shares get off to a good start when dealings begin. So they fix on 125p as the striking price. Since there were applications for 12 million shares at this price or above, not all the applicants will get all the shares they asked for.
Sponsors pitch their price at a level that they expect will attract applications for more shares than are on offer. Or, with a tender offer, they may settle for a striking price below the highest possible. If they are right and there are applications for more shares than are on offer, the offer is oversubscribed. Press reports normally give the extent of the oversubscription.
Then comes the problem of deciding who gets shares, and how many: the allocation or allotment. This depends on policy and on the extent of oversubscription. It may be decided to hold a ballot of all applicants, with the successful ones receiving a standard allocation, whatever they applied for. Or those applying for large numbers (over 100,000, say) may have their applications scaled down to, perhaps, 10 per cent of what they asked for. Those applying for fewer than 100,000 might each get 100 shares, or might be put in a ballot with the successful ones getting 300 shares each and the remainder nothing. It depends on the spread of shareholding that the company and its sponsors want (the big initial privatization offers from the government for companies such as British Gas tended to be structured so as to favour small investors).
Most offers for sale are underwritten. This means that big investors – particularly institutions – agree for a fee to buy any shares that are not bought by the public if the offer is undersubscribed. The vendors – the company or its original shareholders – are thus sure of getting their money. The investment bank sponsoring the issue takes a fee (a percentage of the value of the shares on offer) and pays part to sub-underwriters – investors who agree to take a certain maximum number of shares if required to do so. Underwriting fees are a useful source of income for investment banks and investing institutions and the City does not like tender offers (which are not invariably underwritten).
It is unusual for the underwriter or sub-underwriters to be called on to take up shares. But if an offer for sale is undersubscribed and left with the underwriters you may see references in the press to shares overhanging the market. This may mean that underwriters, who were forced to take up more shares than they wanted, will want to sell them (lighten their holdings). The share price is unlikely to rise far until these shares overhanging the market have been sold and end up in firm hands: with investors who want to keep them.
For the most dramatic case of an issue flop we need to go back to 1987 and the sale of the government’s £7.2 billion stake in British Petroleum in October that year. This was not technically a new issue, as BP’s shares were already listed on the stock exchange. Rather, the government was disposing of its own large shareholding in the company via a secondary issue. But the issue coincided with – and probably helped to cause – the stockmarket crash of that month. As the share price in the stockmarket fell well below the offer price, most of the shares were left with the underwriters and sub-underwriters, who suffered massive losses. They would have suffered still worse losses if the Bank of England had not effectively re-underwritten the part-paid shares by offering to buy them at 70p – a startling case of government subsidy for the private-sector securities houses of Britain and North America. And, as a reflection on the financial sophistication (or lack thereof) of the British public, it is worth noting that over a quarter of a million people applied to buy the government’s BP shares at the offer price, even when it was clear that BP shares could be bought at a much lower price in the stockmarket.
Sometimes, as in the BP case, underwriters earn every penny of their fees. But there has long been criticism of the City’s underwriting system, though probably more in relation to underwriting rights issues (see Chapter 9) than new issues. Standard fees used to be 2 per cent of the issue proceeds and were, the critics argued, a form of cartel. The standard fee paid insufficient attention to the differing degrees of risk in different issues. Supporters of the system argued that the pricing of the issue should help to even out the risk factor, but they have been forced to give ground and accept more competition in setting the fees.
The sponsors of an offer for sale want as little time as possible to elapse between fixing the price of an issue and the receipt of applications. They are vulnerable if the market falls in the interim – as with the BP issue – and the shares on offer consequently look overpriced.
In the case of big issues a pathfinder prospectus is normally made available to major investors and the press some days ahead of the issue. This contains the details of the company and the offer, so that investors can assess them, but leaves blank the vital information on price and prospective yield and PE ratio. This information is then filled in just before the prospectus is officially published. Applications then have to be in, usually within a matter of days, and the basis of allocation is announced a few days later.
Allotment letters go out to successful applicants as soon as possible after the basis of allocation is decided, and unsuccessful applicants get their money back. The stock exchange fixes a date on which official dealings in the shares will start. In practice, shares may be traded in a grey market before shareholders get their allotment letters or even before the basis of allotment is known. In the Financial Times the prices of shares in newly floated companies are listed for a time in a special table in the ‘Companies and Markets’ section of the paper under the heading Recent issues: equities.
The major denationalization or privatization issues – British Telecom, British Gas and the like – worked to a longer timetable because of the size of the issues and the number of unsophisticated investors they were expected to attract. And when there are a lot of companies coming to market, the timetable may in any case vary a little.
Most shares are fully paid. In other words, suppose we are talking of shares of 20p par value being sold at 100p, the buyer or subscriber pays the whole 100p at one go. But sometimes – mainly with the privatization issues and in the case of some gilt-edged stocks (see Chapter 13) – the price is paid in two or more instalments. This means the vendor gets his money spread out over a period rather than in a single lump.
Thus when XYZ Holdings launches, it might decide to sell its shares at 100p but ask for 30p immediately, a further 30p in six months and the remaining 40p in a year. When only 30p has been paid, the shares will be part paid. The Financial Times’s Recent issues: equities table shows the amount paid for each share in a column headed Amount paid up (in pence). Usually the entry is ‘FP’ for fully paid, but not in every case.
Part-paid shares are speculative because they are highly geared. Suppose investors think the right price for XYZ shares is 130p: a 30p premium on the issue price of 100p. In their 30p-paid form, the shares might also be expected to stand at a premium of 30p, so the market price is 60p. This means that anyone who was allotted the part-paid shares at 30p has a 100 per cent profit on his outlay to date, though the shares are only thought to be worth 30 per cent more than their issue price. But it works the other way round, too. If the shares are thought to be worth only 90p against an issue price of 100p, in their 30p-paid form they might be expected to stand at 20p. At that point a subscriber has lost a third of his outlay to date. The problems of the BP issue in 1987 were exacerbated by the fact that only 120p of the 330p sale price was payable immediately, and the value of the part-paid shares roughly halved at one point.
Example 8.1 Information on new issues. Source: Financial Times.
Multiple applications for shares in an offer for sale are, at best, discouraged and in the case of the privatization issues those making multiple applications were threatened with prosecution. Some applicants, including a few moderately prominent figures, were actually prosecuted. A multiple application is when one person fills in a number of different application forms, perhaps with different names and addresses, hoping to get more shares or increase his chances of getting some shares. It is most likely to happen with a popular issue that is expected to be heavily stagged and where there is an almost certain profit when the shares begin trading.
The issuing bank’s normal way of discouraging multiple applications in an offer for sale is to threaten that all cheques sent in will be cashed. If the multiple applicant has borrowed heavily to stag the issue, he is paying large interest charges until he gets the money back in respect of his unsuccessful applications. The Conservative government of the 1980s and earlier 1990s – perhaps because it was selling state assets at less than their true worth to attract the public into its version of popular capitalism – decided that one handout per person should be the limit. This is why it adopted the prosecution route for anyone who attempted to grab more.
In the Internet world, new issues are frequently referred to as Initial Public Offerings or IPOs. So if you are looking for information on up-coming or recent issues, look for an ‘IPO’ button on your chosen website as well for ‘new issues’. A lot of sites now incorporate some information under these headings, including personal finance sites, brokers’ sites and the fundamental information site Hemmington Scott at www.hemscott.net/. A search of the whole web on ‘IPO’ will throw up quite a few leads, but much of the on-line information on new issues relates to the United States markets. The fact that you may see details of an issue does not, of course mean that you will necessarily be able to subscribe. However, Internet-based businesses that are planning to launch on the stockmarket often make use of their website to give information on the issue and arouse investor interest (there may even be preferential applications for their clients).