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The complete beginner’s guide to IPOs

By Bjorn Biel M. Beltran, Special Features Writer

The Philippine Stock Exchange recently announced its goal of having more companies to go public this year. President and Chief Executive Officer Ramon S. Monzon said that the stock exchange has a target for at least three companies and four real estate investment trusts to hold initial public offerings (IPOs) in 2021, which caused no small amount of commotion in the investment community.

But what exactly are IPOs and why are they such a big deal? We have gathered insights from top experts in the investment community to answer these questions.

What is an IPO? Why are they a big deal?

“An IPO is the company’s maiden equity issue of its shares to the public. This occurs when a privately held company sells its shares to the public equity market. It’s transformational for the issuer, from the wealth it creates for shareholders, to the way the company is governed and their ability to fund growth from the equity markets,” First Metro Investment Corporation’s Executive Vice-President and Head of Investment Banking Group Daniel D. Camacho said.

This means that a company is selling either primary or secondary shares or a combination of both to the general public to raise funds for its goals. Primary shares are the offer of new shares, the sale of which would result in proceeds which may be used by the company for its stated work program — capital expenditures, plans income-accretive endeavors, among others. Secondary shares involve the sale by existing, pre-IPO shareholders of their shares to the public.

First Metro Securities Brokerage Corporation President Gonzalo G. Ordoñez added that IPOs often signal a significant development in companies’ growth, and in many ways further legitimize businesses and allow organizations to reach wider audiences. For investors, IPOs mark the very first time the public is given the opportunity to invest in these companies.

“IPOs are considered a big deal in the financial markets because they usually happen only when a company is ready to expand and wishes to finance its rapid growth from the participation of public investors. Usually, a company must have first built up enough goodwill and trust from the investing public before they can even begin to consider taking their company public,” Mr. Ordoñez said.

How can a company go public?

Eduardo V. Francisco, president of BDO Capital, noted that there are multiple parties involved in an IPO, comprising of the issuer; the regulators (Securities and Exchange Commission or SEC and Philippine Stock Exchange or PSE); the underwriting syndicate and its legal counsel; transfer and escrow agents; the issuer’s financial advisory team; as well as the trading participants in the stock exchange.

There is a timeline that can reach up to three years before a company can go public, and this involves the due diligence, documentation, and regulatory approvals before the offer period and actual listing. Naturally, the process is not to be taken lightly, and it requires intense preparation on the part of the issuing company.

The regulatory requirements involved, Mr. Francisco said, range from corporate governance matters, such as the appointment of a compliance officer, to the issuance of reports and disclosures such as financial statements and administrative changes.

“As investment bankers, we are involved with the whole spectrum of activities leading to a company’s IPO. From day one, we assist the company in tailor-fitting the IPO structure based on what the company’s shareholders want and what the market is willing to accept. Sometimes, these two principles are so distinct from each other but it’s part of our job to help create a bespoke structure that is not just acceptable but is actually attractive to the shareholders and the equity capital market alike,” Mr. Camacho said.

“Once the basic structure has been prepared, regulatory filings and marketing activities are the next steps and, once regulatory approvals have been received, determining the price and shares to be offered to the public would be next. The culmination of all these activities would be the listing of the company on the PSE. All these activities can be completed anywhere from six months to over a year, depending on the preparedness of the issuer,” he added.

What are the benefits? Why go through all that trouble?

Mr. Camacho pointed out that the main and most compelling advantages for companies to go public would be the wealth creation generated by the activity and access provided in terms of tapping the equity capital market for funding.

Such funding can be utilized for profit-generating activities which can help spur growth for the business. Other advantages of an IPO include tax-efficiencies, specifically in terms of stock-transaction tax and estate planning, the liquidity provided to investors, the promotion of a more professional organization, and the enhanced public image that the listed company enjoys.

“All these benefits do not come free as a publicly-listed company has numerous responsibilities to its shareholders,” he said.

“Foremost is the sharing of ownership control with other shareholders. Also included is the sharing of financial gain since a listed company is expected to have a dividend policy in place. Other responsibilities or concerns that a potential IPO candidate may face include the time-consuming process of due diligence needed for the IPO, management of the company geared towards maximization of shareholder value, sharing of strategic information through corporate disclosures, costs of going public, and compliance with regulatory requirements,” he added.

Mr. Francisco noted that there is also prestige involved with going public.

“An IPO would raise the public profile of your company with customers, suppliers, investors, and the media, and your company may be covered in analyst reports or be included in an index,” he said.

He added, “There are around 850,000 plus corporations in the SEC but only around 260 listed companies in the PSE. So doing an IPO already puts one in a small unique group. There are also only 3 to 5 IPOs in a year so launching an IPO is a big deal for the Philippine capital market and the PSE.”

When is a company ready to go public?

As noted before, undergoing the process of public listing would give a business access to alternative funding and a broader investor base. It will also demand more from the business in general. Publicly listed companies are beholden to regulatory requirements and restrictions, and are required to be transparent and professional in all its ventures.

“Entrepreneurs should ask themselves if they are ready to adhere to stricter standards of disclosure and governance before fully committing to the exercise,” Mr. Camacho said.

Will receiving equity from the public help support your company’s growth plans? Will you be able to use the proceeds in activities which will help boost the company’s bottom line? Can this help pay off some debts and make your company healthier and more sustainable? Are you ready to professionalize your company and subject yourself to periodic reportorial submissions from the regulators? Are you willing to be more transparent and discuss more the results of operations, as well as plans and strategies with investors and analysts?

If the answer to all these questions is yes, then you are ready to take the next step.

“It takes a while to prepare — can take up to three years to prepare to reorganize the company, fix its audited numbers, hire professionals and directors, etc. There is a lot of housekeeping and requirements to professionalize the company. But if a company and its founders feel that it is time to bring the company to the next level, an IPO is a way to go,” Mr. Francisco added.

Are IPOs a good investment?

As of January 2021, the country’s sole stock exchange, the PSE, has 250 public companies listed, all tradeable through a variety of online and traditional stock brokerage firms, Mr. Ordoñez said.

Through such platforms, any investor can participate in an IPO. The PSE has even set up a variety of ways to reserve shares. One is through clients’ favored stock brokerage firms and another is through the PSE’s own Local Small Investor Program via its PSE Easy online platform.

“Despite many investors believing that IPOs are their first chance to buy companies when their shares of stock are still cheap (or in other words getting in on the ‘ground floor’ of the companies), making money is still never guaranteed,” Mr. Ordoñez warned.

“That is because the share price of the companies once listed may be volatile as buyers and sellers conduct trading activities, or perhaps the future prospects of the company may turn bleak. Increased volatility in the share price movement, and/or the changes in the future prospects of the company may scare off investors causing them to sell and drive down share prices. Though the IPO process is mostly the same for all companies that have undergone it, the outcome of each event varies,” he explained.

How to know if an IPO is worth investing in?
Mr. Ordoñez pointed out that the best companies to invest in are those with clear and achievable expansion plans. Such companies may have outlined their growth through the acquisition of new companies, opening new branches, entering or expanding new markets, researching and developing new products, buying new equipment, or just about any activity that will increase revenue and income.

“Increased revenue and income will translate to dividends and capital appreciation for investors. It is for these initiatives that the companies will use the IPO proceeds for. Companies such as these will make investing and holding the shares of stock, despite increased volatility, worth it,” he said.

As with all things in the investment market, however, it all comes with risks. Potential investors should do adequate research and conduct a careful study of the company. Reading the prospectus of the company and research reports are a good start, as is doing a careful survey of its management team and track record. Investors should know what they are buying, and have some estimation of the value of the shares.

But perhaps most important of all is the why, Mr. Ordoñez noted.

“What is the reason for participating in the IPO? Is it to invest in the company, to grow capital coinciding with the growth of the business? Or is it simply to trade the share price once listed, taking advantage of the high trading volume, buying low and selling high?” he said.

“Knowing the WHAT and the WHY will greatly help investors assess the investment, and properly weigh the risks and rewards of participating in the IPO. Every investor’s goal is to grow capital. Every trader’s goal is also to grow capital. Doing this exercise simply matches the goal with the investor or trader’s strategy, and the nature of the investment,” he added.

The decision whether to invest in the new IPOs that the PSE is eyeing depends on the investor. Mr. Francisco noted that despite the pandemic, the Philippine investment market has fared well, seeing its first real estate investment trust last year and also the largest IPO to date in Converge.

“There are several IPOs slated this year that could again set new records in size. The success of our IPOs last year and this year reflects well on the Philippines. Foreign investors will not invest in our IPOs if they do not believe in the Philippine story,” he said.

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