IPO: Russia's Experience and Kazakhstan's Outlook
Askat Ospanov, Lawyer for SayatZholshy & Partners
Askat Ospanov is an expert in foreign exchange regulation, subsoil use law, foundation, reorganisation and winding-up of legal entities, and in contractual and corporate law. Currently, he is in charge of developing a new domain for Sayat Zholshy & Partners—legal services in the sphere of corporate finance
In this article we will discuss an advanced instrument in the development of Kazakhstan's financial market, the Initial Public Offering (IPO). As an example we can describe Russia's experience, where successful IPOs implemented by some big companies drew the attention of local financial market participants and enterprises in the real economy. In opinion of analytics, the Kazakh equity securities market is one of the most developed among CIS countries, this confirms that after a time, IPO will come to our country as well.
An IPO is the sale of a company's shares to public investors via securities exchange. However, the literal translation of Initial Public Offering, as the initial offering of securities1 to the public, inaccurately reflects essence of this instrument. An IPO means that shareholders of an acting company decide to sell a part or additional shares of stock to a wide range of investors. IPO publicity assumes, that for a successful sale of shares, company must be 'opened', i.e. all potential investors must be given the opportunity to scrutinise the company's internal structure, financial status, prospective business tendencies, etc.
1. Shares are not always used for IPO. Many companies entering international financial markets prefer issuing depositary receipts, the number of which is a fixed proportion of the numbers of shares (e.g., 1 share is equal to 50 depositary receipts).
IPOs are widespread in the U.S. and Western Europe. Many companies use IPOs as the most effective way of attracting additional investments and of evaluating the business's fair-market value.
As a rule, the following objectives are pursued in the course of an IPO:
I. Disclose company's information to public
As stated above, for an initial public offering, a company must be ready to disclose its internal information to all potential investors. To gauge the degree of information transparency, refer to prospectuses of share issues published by western companies in the process of going public.
· These prospectuses contain the following information:
· The expected use of funds received from the sale of the shares;
· Changes in the company’s profits;
· Information on all the shareholders;
· The company's internal structure, including information on compensation/fees paid to senior management;
· A list of major clients and suppliers;
· Information on competitors.
Becoming a public entity consolidates a company's reputation. In the future, public companies can rely on favourable market conditions for the lending or borrowing of money.
Moreover, as noted in Russian business publications, the public status of a company can serve as a safeguard against governmental claims. Considering the situation with YUKOS, some stock market analysts suggested that such measures would not have been taken against a public company, as they could affect the interests of a wide range of shareholders—from big investment banks to individuals.
II. Attract additional investments
In contrast to credits and debenture (bond) issue, investments attracted by going public are not tied to certain terms. In the opinion of investors, this is more risky, as profit depends mainly on the effectiveness of the company's shares which they purchased as a result of IPO. If business owners choose an IPO as an instrument to attract investments, they must decide whether they are ready to share their profit with new shareholders.
Fast-developing companies that operate in high-risk economic sectors often go public.
Such companies very rarely organise common debt financing by means of debentures or bank credits due to the very high risks of profit loss. On the other hand, work in risky sectors can bring huge dividends.
For example, in the early 1990s in the U.S., there was an IPO boom for companies in the high-tech arena. Then, after several high-profile bankruptcy cases involving big telecommunication companies, a certain cooling took place in this sector. At present, this sector is again becoming exuberant, as demonstrated by the great results of Google’sIPO.
In Russia, an IPO boom for companies working in the area of high technologies is occurring as well (e.g., VimpelCom, RosBusinessConsulting, and the Joint-Stock Financial Corporation "Systema", the owner of the MTS brand, all went public).
III. Get company's market estimation
It is acknowledged that only the market is able to estimate a business's value. Price dynamics of a company's stock in the course of an IPO is the most accurate indicator of that company's effectiveness. Shareholders or managers can estimate the value of their business on the basis of the results.
In practice, there are situations when an IPO implemented to determine market value had precedence in the subsequent sale of a business by its owner. In spite of the fact that as a rule, the transaction objectives are different for each party (on the seller's side, it is important not to sell too cheaply and on the buyer's side, it is important to buy at the most objective price), after an IPO, counter parties tend to agree on price rather quickly.
For example, Dmitry Zimin, the main shareholder of VimpelCom, sold his shares to the Alfa Group for $27.4m. Prior to the conclusion of this transaction there was a public offering of VimpelCom'sshares on the New York Stock Exchange.
IV. Reinforce the brand
An IPO has a favourable influence on a company's brand. Large-scale advertising campaigns are carried out for more efficient share placement. With this, an advertisement or a road show is directed toward institutional investors, active participants of a stock exchange, and to companies and individuals—the wider the range of potential buyers, the more successful the placement.
Large-scale advertisement and successful share placement increase a company’s brand recognition and therefore, attractiveness.
The IPO mechanism will be clear if the process of implementation is divided into separate phases2.
2. The following phases were taken from The Practical Guide on Initial Public Offering (IPO) by Pavel Gulkin, Saint Petersburg, 2002.
Phase 1. Selection of an underwriter and the involvement of other consultants
When a company decides to go public, it starts looking for an appropriate underwriter, whose role is extremely important in IPO process. An underwriter (as a professional participant in the stock market) can predict IPO results on the basis of a company's business profile.
An underwriter assists the company to select an IPO strategy and prepare relevant documents (prospectuses and investment memorandums).
In addition to an underwriter, other consultants are also involved in the preparation phase. For example, these are legal companies participating in the due diligence process. Whereas an IPO includes broad advertising campaigns, it is also possible to involve advertising and PR consultants.
Phase 2. Preparation of issue documents
In this phase, the issuing company, the underwriter and other consultants prepare a prospectus and investment memorandum drafts, define information disclosure parameters, stock placement method and other issue conditions.
At the same time due diligence is also implemented to determine the real financial status of a company and identify all possible risks and development prospects.
Phase 3. Marketing
This phase includes large-scale publicity campaigns to present a company to investors. 'Road shows', or numerous presentations in different cities, are often carried out within such actions.
At present, many companies advertise themselves in virtual form (via the Internet), which allows them to reach significant audiences. Moreover, costs incurred by virtual presentations are much lower than costs of conventional 'road shows'.
During the marketing phase, issuing companies together with the underwriter try to gauge investor's interest in shares, effective share placement, optimum share price, and the number of issued shares. A final prospectus is prepared after such research is conducted.
Phase 4. Registration of the stock issue
In practice, this phase was called the Waiting Period. Such name was given because the laws in the absolute majority of countries prohibit any share transactions from taking place until the issue is registered in the stated order.
During this phase, documents are sent to competent governmental agencies to register a share issue. For example, such an agency in Russia is the Federal Financial Market Agency, in Kazakhstan, it is the Agency for Regulation and Supervision over the Financial Market.
In the U.S. (during this phase), an underwriter collects proposals, or Indications of Interest from potential buyers. This allows the underwriter and issuing company to predict placement effectiveness.
Phase 5. Share trading
A key IPO phase is the direct placement of issued shares among investors. Effectiveness of this phase depends mainly on quality of previous preliminary phases, especially on correct marketing.
Phase 6. Placing summation
Upon placement completion, an issuing company must send a report on share placement for a governmental agency's approval. Moreover, an issuing company estimates IPO effectiveness.
If there is talk on prospects for IPOs in Kazakhstan, one should expect that in the near future, domestic companies would not choose to go public via the internal market. The following facts can serve as reasons:
· An IPO is very costly and usually executed by very big companies. It is possible to manually count such companies in Kazakhstan; the majority of them have a governmental stake. There are no big private companies that are ready to provide absolute transparency or go public. Those companies that have potential to go public tend to carry out IPOs via international capital markets. For example, the Kazakhmys company, whose stock is in good demand in the market, preferred to leave KASE and placed its shares on the London Stock Exchange.
· As stated above, one of the most important requirements for an effective IPO is a company's full transparency. Any interested investor must have the opportunity to scrutinise the company's financial state and to estimate its development prospects. In our opinion, big Kazakh companies are not ready for such transparency. In practice it is impossible to obtain information on a company's shareholders, affiliates, financial indices, or other pertinent information from public sources.
· In spite of the fact that there is available capital for investment in the financial market (assets of pension funds), the real opportunities for investment are quite limited. The remaining potential investors (citizens, small and medium-size companies) are suspicious of the securities market and prefer invest their available money into more 'clear' sectors such as realty or bank deposits. In this regard, a company planning to go public via the internal market will likely encounter an insufficient number of investors interested in purchasing the issued shares.
· Kazakh laws regulating share issue and placement do not take IPO peculiarities into account. As an example, below are two provisions that can have a negative impact on a company's decisions to go public.
To achieve successful IPO results, an issuing company shall place the majority of shares on the informal market, as the range of potential investors in the formal market is extremely limited. For example, in accordance with the effective prudential standards, a pension fund can invest up to 10% of its assets in shares of one Kazakhstani issuing company. In this case, the following provisions of the Kazakh laws will face an issuing company:
1. In accordance with Clause 3, Article 22, of the Kazakh Law of 2 July 2003, On Securities Market, shares can be placed by means of an auction or subscription on the basis of investors' written requests to an issuing company. Whereas one of the major objectives of an IPO is to attract additional investments, auction share placement is more preferable as the auction method of share pricing allows the maximum possible price per share. In accordance with Chapter 77 of the Kazakh Tax Code, an auction charge is paid in cases of property (property rights) sales in auctions. In accordance with Article 429 of the Code, an auction charge is 3% of the property marketing cost defined on the basis of auction results. Considering the IPO-related costs paid by an issuing company, the obligation to pay an additional auction fee can be a reason why a company refuses to go public. At the same time, Clause 2(6), Article 428 ofthe Tax Code provides that cost of property (shares) can be exempt from auction charge at stock exchange auctions. In our opinion, the introduction of changes, such as the cancellation of auction fees pertaining to public securities placement, can have a positive impact on IPO development in Kazakhstan.
2. In accordance with Clause 3, Article 24 of theLaw On Securities Market, any report on securities placement results shall be reviewed by the Agency for Regulation and Supervision over the Financial Market within 14 days. Such a term for report approval is quite acceptable for common share placements when an issuing company has an idea about number and stakes of shareholders at the end of placement. But another situation occurs during the course of an IPO, when an issuing company is required to get information on placement results as soon as possible. However, it is not possible to know IPO results until the report on placement is confirmed. Investors are also interested in the early receipt of information on IPO results. First, an IPO's positive result justifies the decision to purchase shares as this demonstrates high investor demand for the stock. Second, investors who base their investment decisions on share placement reports can decide to purchase other distributed shares of the same issuing company.
It is necessary to note that in Russia when an IPO is implemented in the internal market, companies encounter the same problem (in particular, RosBusinessConsulting3). However, after discussion of this issue with the Financial Market Federal Agency's management and publications by the Russian financial press, the Agency has decided to reduce IPO approval period to one day, which is expected to take effect in the near future.
3. Magazine Financial Director, No.6, December 2002.
In conclusion, we would like to state that in spite of present barriers that prevent IPOs in Kazakhstan, in the future, this instrument can be widely spread in the implementation of development plans for the financial sector and the organisation of favourable conditions for professional participants in the stock market.
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