Feb 172014
 
What should investors know about IPOs?

The year 2014 is expected to be a promising year for the Sri Lankan equity market. The All Share Price Index has witnessed a growth of nearly 5 percent within one month. Further on, analysts predict an increase in market activities especially in the primary market as a result of the expected increase in Initial Public Offerings (IPOs). Today’s article will address vital issues pertaining to investing in an IPO and the role of the regulator and the exchange.

The post-war experienced an IPO boom and certain investors invested without obtaining sufficient knowledge about the company. Some IPOs reaped short-term returns while others reaped long-term returns. Failing to understand this many expected unusual returns on the first day. The situation further aggravated when they invested in IPOs even when they did not go in line with their investment goals.

It is not always possible for the stock price to go up rapidly within the first few trading days. The mismatch between the performance of IPOs and investor expectations was unhealthy towards the growth of the primary market. Hence, the article will disseminate knowledge required in making wise investment decisions and thereby enable investors to maximize their profits.

Role of regulator and an exchange
It is disheartening to see how both new and seasoned investors at times fail to understand the role of a regulator and an exchange. Both parties have distinct roles within the market. Failing to understand these roles investors turned towards the aforesaid entities during the post-war IPO boom (irrespective of whether it fell under the purview of the regulator/exchange). The Securities and Exchange Commission of Sri Lanka (SEC) as a regulator plays a duel role of regulating the exchange of securities and developing the capital market, while the Colombo Stock Exchange (CSE) provides infrastructure for trade.

What is an IPO?
There are many ways in which a company could raise capital. One such method would be to offer company shares to the public at a pre-determined price. Companies offer shares to the public through IPOs. By doing so, a company goes from the status of private to public.

Who determines the price of a stock at an IPO?
A company that intends to raise capital for an upcoming investment could enter the market through an IPO. The price of a stock is of utmost importance for the company as it determines the total capital received. The amount of capital, type of stock (voting or nonvoting) and above all the issued price of a stock is determined by the company in consultation with the investment bank they work with. It does not fall under the purview of the regulator to intervene in deciding the price of a stock. It is not the practice even in developed capital markets.

How is the offering price determined?
In simple, the offering price is determined by a mix of market conditions and financial analysis. However, it is important to bear in mind that competing interests affect the determination of the offering price.

At the beginning, an investment bank and the company will decide the price based on one or more of the following standard methods.

Relative valuation multiples- This method is usually used to value young and high-growth companies with limited historical information. The company is valued on a multiple of the earnings per share generated or on enterprise value to earnings before interest, tax, depreciation and amortization.

Discounted cash flow valuations- This approach is usually used for mature companies that generate steady free cash flows.

Sum of parts valuation- This method is usually applied to companies that have distinct business segments with different outlooks for profitability and growth that need to be valued separately.

After the valuation process is completed the investment bank would approach potential key investors to get an indication on the price they are ready to pay. The final offer price is a midpoint of the offered price and asked price.

Are there any other factors considered when determining the stock price?
Even though financial analysis plays a pivotal role in determining stock prices many other factors could influence the price that at times would be contrariety to financial analysis. A company may command a higher valuation if they expect a positive and drastic change in the outlook of the company/industry which would increase company profits, revenue and earnings.

Market sentiments at the point of entering the market might also influence the offered price. The same company might set a higher price during a growing market and a lesser price when the market  is experiencing a downward trend.

Another aspect of IPO valuation is industry comparables. If the IPO candidate is in a field that already has comparable publicly traded companies, the IPO valuation may be linked to the valuation multiples being assigned to competitors.

Why does not the regulator intervene in determining the price of a stock?
The key aim of regulation is to create a ‘conducive environment required for the efficient functioning of financial markets’. They create a conducive market and allow market forces to determine prices. If the regulator intervenes in the pricing mechanism in an unwanted manner it will not reflect the true value of the stock and result in price distortions. This could lead to inefficient markets.

What should investors know about the issued price?
The amount of capital raised is determined by the price of a stock. If there is a higher price the capital will increase while the capital might reduce if they put down the issued price. On the contrary, if the issued price is too high, the demand will be less pushing down the capital. Hence, the issued price can be a tradeoff between the two. Thus, it is important for investors to be vigilant when investing in an IPO.

How do investors decide on an IPO?
Decision to invest in an IPO should be based on solid reasoning. It was disheartening to see how certain investors bought shares through IPOs during the post-war IPO boom without sufficient research on the company. Solid reasoning requires sufficient information on the company which could be obtained by reading the prospectus issued by the company.  

(To be continued next week)

Jan 052014
 
Brokers seek permission to close shop temporarily
Several struggling stock brokers have written to the Colombo Stock Exchange (CSE) requesting permission to temporarily halt their operations mainly due to low activity levels in the bourse, Mirror Business learns.

This was confirmed by Securities and Exchange Commission (SEC) Chairman Dr. Nalaka Godahewa during an inquiry.

“There is a proposal by several brokers requesting temporary deactivation of their operations. The CSE has forwarded it to us and we are considering it. We have not discussed it with the Commission yet, but at the secretariat level, we are looking at it positively,” Dr. Godahewa said.

He further said, it was not a “bad idea” as it has happened in many other markets as well.

“You allow those who are struggling to remain deactivate for a while. It will give more opportunities for others who will continue to operate in the market,” he noted. Altogether 29 stock brokers currently operate in the CSE, and many are of the opinion that the number is too high for all to sustain their businesses.

A number of new broking licenses were issued just after the conclusion of an almost three decade war in 2009—at a time when the market was undergoing a re-rating.

In 2010 and 2011, the daily average turnover stood over a couple of billion with the arrival of new set of retail investors into the market, providing ample opportunities to brokerages to make money.

However, in 2012, with the market undergoing a painful correction, the euphoria died down and many new retail investors burnt their fingers.

The daily average turnover in 2012 plunged to Rs.883.6 million, creating a highly competitive environment for brokers to operate. The daily average turnover in 2013, according to latest CSE figures, stands even lower at Rs.828.4 million.

“I think there are far too many brokers in our market. But like the Central Bank who has told the finance companies to consolidate, we have not told brokers to do so. The industry has to decide on its own. We are not going to tell them how to do business,” Dr. Godahewa stressed.

Jan 052014
 
Brokers seek permission to close shop temporarily
Several struggling stock brokers have written to the Colombo Stock Exchange (CSE) requesting permission to temporarily halt their operations mainly due to low activity levels in the bourse, Mirror Business learns.

This was confirmed by Securities and Exchange Commission (SEC) Chairman Dr. Nalaka Godahewa during an inquiry.

“There is a proposal by several brokers requesting temporary deactivation of their operations. The CSE has forwarded it to us and we are considering it. We have not discussed it with the Commission yet, but at the secretariat level, we are looking at it positively,” Dr. Godahewa said.

He further said, it was not a “bad idea” as it has happened in many other markets as well.

“You allow those who are struggling to remain deactivate for a while. It will give more opportunities for others who will continue to operate in the market,” he noted.

Altogether 29 stock brokers currently operate in the CSE, and many are of the opinion that the number is too high for all to sustain their businesses.

A number of new broking licenses were issued just after the conclusion of an almost three decade war in 2009—at a time when the market was undergoing a re-rating.

In 2010 and 2011, the daily average turnover stood over a couple of billion with the arrival of new set of retail investors into the market, providing ample opportunities to brokerages to make money.

However, in 2012, with the market undergoing a painful correction, the euphoria died down and many new retail investors burnt their fingers.

The daily average turnover in 2012 plunged to Rs.883.6 million, creating a highly competitive environment for brokers to operate.  The daily average turnover in 2013, according to latest CSE figures, stands even lower at Rs.828.4 million.

“I think there are far too many brokers in our market. But like the Central Bank who has told the finance companies to consolidate, we have not told brokers to do so. The industry has to decide on its own. We are not going to tell them how to do business,” Dr. Godahewa stressed..

The trading floor of the Colombo Stock Exchange

Dec 262013
 
SEC to amend disclosure rules on director dealings
The Securities and Exchange Commission is expected to amend the listing rules pertaining to disclosures on director dealings, to chuck out some ambiguities that have fuelled late disclosures by some parties.

According to SEC Deputy Director General/Officer in Charge, Dhammika Perera, a specific time period will be indicated in the new rules for directors to disclose their dealings.

The Colombo Stock Exchange’s present listing rules direct listed entities to make an immediate announcement of disclosures made by a director in terms of Section 200 of the Companies Act.

The Section 200 of the Companies Act requires directors to make disclosures of an acquisition or disposal of shares of their companies to the board of directors.

Those familiar with the regulatory aspects in connection to director dealings said, most of the directors tend to use the infrequency of board meetings as an excuse to make delayed disclosures.

Oct 042013
 
Amana planning CSE listing this year
Amana Bank is planning to list shares on the Colombo Stock Exchange (CSE) before the end of this year.

A company representative told Mirror Business that preparations for listing are currently underway, reiterating that more information with regard to the listing would be announced in the coming months.

In the past, Amana Bank has periodically stated that steps were being taken to list as per CBSL regulations.

The Central Bank of Sri Lanka (CBSL) required all private banks to be listed on the Colombo bourse by 31st December 201,1 in order to enhance banks’ ability to raise additional capital in a more transparent manner, with a view to improving governance through market discipline.

The listing requirements were issued parallel to increased minimum capital requirements as part of a larger policy from the CBSL to improve the domestic banking sector’s ability to withstand internal and external shocks.

Aug 052013
 
Bleak outlook for financial sector in 2013
Sri Lanka’s banking, finance, insurance and real estate sector (financial sector) will have a bleak outlook for 2013 on the back of low credit growth and deteriorating asset quality, an equities research report by a leading securities trading firm said.

JB Securities said in its report, the poor performance of the financial sector would be further aggravated by the falling net interest margins (NIMs) due to timing mismatches in reprising assets and liabilities and the absence of one off translation gains from a large depreciation of the currency.

Despite two rounds of monetary easing since last December, private sector credit growth has remained subdued. By end-April 2013, credit to the private sector grew only by 10.2 percent, followed by a 9.0 percent growth in May, notably below the Central Bank’s full year target of 18.5 percent.

It was only last month that C T Smith Stockbrokers alerted a possible deterioration in the asset quality of the gold-backed loans (pawning portfolio) to around 3 percent from around 1 percent if gold prices fall below US $ 1,000 an ounce.

By April 2013, pawning as a percentage of total rupee lending stood at 22.8 percent, slightly elevated from 2012’s level of 22.6 percent. However, JB Securities expects a contraction in pawning advance for the balance part of the year because of the lower gold prices, coupled with lower loan-to-value ratio.

Meanwhile, the economists too pointed out the penal rate cut, which came into effect since August 1, would also give an incentive for the borrowers to default and thus affecting the asset quality negatively.

According to TKS Securities (Private) Limited, the cap on penal rates will negatively impact the banks because the banks have to cut rates from current 5.0 percent – 6.0 percent to 2.0 percent.

However, a banking sector analyst said on condition of anonymity that the policy directive could even turn out to be positive to the overall economy because despite yields coming down, borrowers would be encouraged to repay in larger volumes, leaving more funds for relending, leading to credit growth.

The financial sector accounts for 30 percent of the market capitalization and 37 percent of the total earnings in the Colombo Stock Exchange.

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