Revving up the capital market (2)

Taking off from my article last week, let’s do a deep dive into how to rev up the capital market. It begins with the number of issuers in the market, where we severely lag behind our regional neighbors. The pivotal event that triggers the whole cycle usually starts with an enterprise in need of long-term funding, typically either to finance an expansion of its operations or simply to rebalance its capital structure by lengthening the maturity of its debt profile or by decreasing the leverage levels through an infusion of fresh equity.

So why aren’t there enough listed stocks in the PSE to give investors a wider choice? The usual go-to reasons for corporates to list — which are “free” cash proceeds from the IPO either for the issuing company for primary issuances, or the partial exit of shareholdings at substantial premium for secondary shares sales with only the minimal stock transaction tax to contend with compared to the more expensive transfer tax, or the revaluation of shareholdings post-IPO — aren’t apparently viewed as compelling enough compared to the tedious hassle and expense of having to comply with the extensive scrutiny of pre- and post-IPO regulatory compliances any prospective issuer has to go through.

First is because of the relatively easy access to reasonably priced funding because of the prevailing liquidity of the banking system and the general trend of lower interest rates. For IPO–ready candidates, the financials are likely in good shape, attracting a host of competing banks with wallets wide open, thus bank borrowings are an easier path to take.

Second, more often than not, a corporate restructuring would be necessary because of usual legacy issues involving any tax deficiencies and/or unresolved legal disputes or an accounting of unconsolidated financials of different operating affiliates, which will require consolidation under one corporate holding company. And to clean up these issues, the timeline could easily take a year or two to complete, a length of time too late for businesses that need immediate long term funding. Furthermore, a start-up business with no track record but with very good potential, say, in Artificial Intelligence applications development, will not be eligible to do an IPO.

Third, the expenses incurred in an IPO for various fees, such as for consultancy, legal, auditing, brokerage, and underwriting, compared to the more convenient mode of just negotiating bilaterally with a few banks, render the IPO mode unattractive and too costly.

Fourth, a public listing will mean dilution of ownership, albeit usually quite manageable, perhaps up to about a third of the company’s issued shares.

Fifth, decisions will probably take longer because of the SEC requirement for Independent Directors to represent all stakeholders who may not be as intimate with the operations as Executive Directors. Of course, a well-governed company can mitigate this with a thorough onboarding of new Directors and efficient pre-board meeting committees such as the Audit, Risk, and Compliance committees that can review, vet and endorse to the Board any proposal prior to the en banc Board meeting proper.

Sixth, a fully transparent business operation as expected of all listed firms may not be to the advantage of the majority shareholder used to solely deciding and managing an unlisted firm. Furthermore, board deliberations and decisions will have to be reported forthwith to the public, prejudicing any intended strategic moves such as acquisitions and mergers, which ideally should be negotiated confidentially. Minutes will no longer be private because any stockholder can legally demand full access and disclosure of the minutes and resolutions of the board.

Seventh, for several years now, the valuation of most shares, post-IPO, after an initial flurry of speculative trading, primarily because of the issuer’s support fund, dried up; the share price typically starts dropping, settling finally at a deep discount of the original IPO price, leaving a bad taste in the mouth for the issuers and investors alike. Consequently, any future plans for a re-issuance becomes unlikely. Significantly, such a scenario discourages long-term institutional investors because any future exit strategy becomes a problem.

There are a host of other issues of course, that I hope to cover in future issues, but the above should give you a glimpse of what lies ahead for our capital market unless some structural changes and a full-on cooperation of all stakeholders, both the private sector and the government, will take place.

Until next week… OBF!