IPO Related Issues

Abstract:
The purpose of this paper is to highlight Initial Public Offering related
issues.
When a company sells stock to the public for the first time it is called
an initial public offering. Once a company becomes public it has to
disclose so much information to public on regular intervals.
Implementation of any key decision takes time; the cost of the process
is very high and so many other issues. Then Initial Public Offering of
HBL is also discussed in this paper. It is concluded that a company
should consider the advantages and disadvantages of IPO before
deciding to go public. IPO related issues can be minimized by better
planning.

Introduction:

IPO stands for Initial Public Offering. As the name suggests it’s the
process wherein a company goes to public for the first time for raising
money by offering ownership in the company. In this process a private
limited company becomes Public Limited Company. Companies offering
an IPO are sometimes new, young companies, or sometimes
companies which have been around for many years but are finally
deciding to go public. IPO’s are often used as a way for a young
company to gain necessary market capital. When a company decides
to go public, it first hires an underwriter, usually a large investment
bank. The underwriter agrees to buy all shares of the company’s stock
minus the investment's firm commission, usually about 5 to 7 percent.
After a successful offering, the underwriter meets with all parties to
distribute the funds and settle all expenses. At that time the transfer
agent is given authorization to forward the securities to the new
owners. An IPO closes with the transfer of the stock, but the terms of

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the offering are not yet completed. The Security and Exchange
commission of Pakistan (SECP) requires the filing of a number of
reports pertaining to the appropriate use of the funds as described in
the prospectus.

What Is Stock Exchange?

A stock exchange is a forum for trading in securities representing
shares of firms. An exchange provides ways by which financing is
raised by the sale of shares to outside investors. Exchanges have two
clienteles: companies, which list their shares, and investors, who trade
on the exchange.
A stock exchange, share market or bourse is an organization which
provides "trading" facilities for stock brokers and traders, to trade
shares of the listed companies and other financial instruments such as
Term Finance Certificates and Derivatives. Stock exchanges also
provide facilities for the issue (listing), redemption (delisting) of
securities and other capital events including the payment of income
and dividends. Karachi Stock Exchange (KSE) is a modern market
where trading takes place with electronic trading system called Karachi
Automated Trading System (KATS), which gives the Exchange
advantages of speed and minimum cost of transactions. Trades on an
exchange are by members only.
What are Shares?
A unit of ownership interest in a corporation or financial asset. Each
shareholder is a partial-owner of the company in which they have
bought shares and investors can buy and sell their shares on the stock
exchanges. Companies on incorporation issue shares, (also called
equities) and later perhaps when they are building up a business. While
owning shares in a business does not mean that the shareholder has
direct control over the business's day-to-day operations, being

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a shareholder does entitle the possessor to an equal distribution in any

profits, if any are declared in the form of dividends. The two main types
of shares are common shares and preferred shares.

Common Shares
When we buy common shares we become a part owner of the
company. We will share in the profits of the company if it does well,
either by seeing the value of your shares rise, by being paid dividends
out of the firm's profit, or both. If the business performs badly, you
probably won't get any dividends and the value of your shares will
drop.
Preferred shares:
A preferred share is a special type of stock that regularly pays you a
set amount of money out of the company's profits called dividends.
They're called preferred because you get preferential claim to the
profits ahead of common shareholders.
Why Do Companies Go Public?
The primary purpose for companies to be publicly listed at the
exchange is to cost-effectively raise capital. It reduces the company’s
reliance on the traditional financiers such as financial institutions and
individuals. The most common reason is that capital raised through an
IPO does not have to be repaid, whereas debt securities such as bonds
must be repaid with interest. Listing allows business expansion without
increasing borrowings or draining the company’s cash reserves. History
of listed companies indicate that companies that convert to public
ownership are more likely to become successful than control
companies that remain private. Companies that go public are also
more likely to become acquirers than control companies. IPO
companies grow faster than control companies after going public.

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However, both public and private companies must disclose financial

information to regulators.

IPO Process:

In order for a company to sell IPO’s, it must get one or several

investment banks involved in the process. These banks are referred to
as underwriters and the company enters into a legally binding
agreement with the lead underwriter that gives it permission to sell
shares of the company to the public. Most IPO’s are underwritten by
what is referred to as a syndicate of investment banks, which are
several banks that are headed by one or several major investment
banks. The bank or banks leading the syndicate become the lead
underwriter. Once the company enters into an agreement with an
underwriter, the underwriter then offers shares to investors that may
be interested in purchasing them. Once the underwriter sells the IPO,
the company receives a commission that is based on a percentage of
the IPO's value. The underwriters selling the largest proportions of the
IPO usually receive the highest commission. In some cases, this can be
as much as 8%.

The underwriting process:

When a company wants to go public, the first thing it does is hire an
investment bank. Underwriting is the process of raising money by
either debt or equity. Underwriters are middlemen between companies
and the investing public.
The company and the investment bank will first meet to negotiate the
deal. Items usually discussed include the amount of money a company
will raise, the type of securities to be issued and all the details in the

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underwriting agreement. In a firm commitment, the underwriter

guarantees that a certain amount will be raised by buying the entire
offer and then reselling to the public. In a best efforts agreement,
however, the underwriter sells securities for the company but doesn't
guarantee the amount rose.
Once all sides agree to a deal, the investment bank puts together a
registration statement. This document contains information about the
offering, company info such as financial statements, management
background, any legal problems, where the money is to be used and
insider holdings. Then underwriter and company attempt to hype and
build up interest for the issue.
As the effective date approaches, the underwriter and company sit
down and decide on the price. This isn't an easy decision: it depends
on the company, the success of the road show and, most importantly,
current market condition. Finally, the securities are sold on the stock
market and the money is collected from investors.

Issue Price:
A company that is planning an IPO appoints lead managers to help it
decide on an appropriate price at which the shares should be issued.
There are two ways in which the price of an IPO can be determined:
either the company, with the help of its lead managers, fixes a price or
the price is arrived at through the process of book building.
General Issues Before Going IPO:
Issues before going IPO are:

Access to IPO Markets:

Access to IPO markets, fundamentally, depends on the state of the

economy and equity market conditions at the time a company is ready
to undertake an IPO. If economic and market conditions deteriorate
around the time that a company wants and needs to go public, it is

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very difficult to complete a successful IPO. A valuation acceptable to

the marketplace may not provide sufficient capital to the company and
could unduly dilute the ownership and valuations of existing
shareholders to the point where it is not feasible to undertake the IPO.
This could lead to immediate failure or prolonged problems for a
company.

Financial Position:

Over and above the timing issue, however, a company must prepare
itself internally to be ready to go public. Usually, a history of strong
earnings is required to make a company attractive to investors but
other factors such as management expertise, innovative new products
and a new business concept can allow a company to go public even
with little or no earnings. The key to any company's ability to
undertake an IPO is a strong, capable and experienced management
team and a prominent Board of Directors.

Growth Potential:

High growth potential is another key sign of readiness by either a

consistent record of high growth or, at least, the potential for high
growth. A company's position in an industry is often linked to holding
patents, copyrights, trademarks, and other proprietary advantages and
investors often look to these as evidence that the company can earn
higher than average profits and return on assets. Before going public, a
company should have strong tangible net asset holdings that would be
sufficient to get it through a difficult post-IPO environment.

Post IPO Issues:

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The issues brought about through the flotation of a company in an IPO

are typically perceived differently by different companies with different
focuses and requirements.

 Potential loss of control

 Increased disclosure of information
 Costs of IPO’s
 Potential restrictions on management action
 Emphasize on short-term performance
 Decisions takes time

Potential Loss Of Control:

Not all IPO’s are for more than 50 per cent of the issuer’s voting
shares, in fact, the average is around 30 per cent. So although control
is not lost through the IPO, if the company requires further equity to
fuel its growth, existing shareholders will suffer dilution. For the
majority of companies, control will pass to public shareholders at some
point in time. If a large portion of the company's shares are sold to the
public, the company may become a target for a takeover, causing
insiders to lose control. A takeover bid may be the result of
shareholders being upset with management or corporate raiders
looking for an opportunity.

Increased Disclosure Of Information:

When a company moves from private ownership to public, it vastly

increases the number of people who have access to its financial
records. Public companies release all operating details to the public,
including sensitive information about their markets, profit margins, and
future plans. This can be a huge shock to the existing owners, not just
the reporting of the company’s results, but the disclosure of

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management salaries and perks that often piques the interest of

newspaper editors on a slow day.

Companies are required by stock exchanges, securities commissions

and regulators to disclose information on a regular basis so that
investors and potential investors can make buy, sell or hold decisions.

Costs Of IPO’s:

Initial public offerings aren’t cheap. Investment bankers take

commissions of between 2 and 7 per cent of the total amount raised;
lawyers and accountants bill by the hour, and many hours are required.
The ancillary costs, such as public relations, printing, corporate
advertising and others can add several hundred thousand more dollars,
euros or pounds.

However, the direct costs of an IPO can pale beside the indirect cost of
under pricing. Because no cash is coming directly out of the issuer’s
pocket, under pricing can sometimes be ignored as a cost. It should not
be. IPO’s around the world are under priced compared with their short-
term performance. On average, an IPO will close at a price that is 15 to
20 per cent above its issue price, although this varies by market and
industry and over time. This means that selling shareholders and the
company are leaving significant sums of money on the table when they
go public.

Potential Restrictions On Management Action:

In public companies, the managers are the agents of the shareholders

– they should be acting on behalf of the shareholders and in the
shareholders’ best interests. In order to ensure that they do, public
companies have boards of directors who are meant to oversee
management’s actions on behalf of shareholders. In some

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circumstances a strong board of directors may limit the actions of

management. Going public gives management less control over day-to-
day operations

Emphasize On Short-Term Performance:

Public entities also face added pressure to show strong short-term

performance. Earnings are reported quarterly, and shareholders and
financial markets always want to see good results. Unfortunately, long-
term strategic investment decisions may tend to have a lower priority
than making current numbers look good.

Decisions take time:

Implementation of any key decision is subjected to the approval by the

board of directors elected by share holders. This process may take
more tim

HBL at a Glance:

HBL is a Banking Company, which is engaged in Commercial & Retail

Banking and related services domestically and overseas. HBL was
incorporated on 25th August 1941 and operated in the private sector
until its nationalization in 1974. HBL has been approved for
privatization and the privatization commission has selected a Financial
Advisor to prepare a comprehensive plan and assist in the sale
process. HBL is one of the largest commercial bank of Pakistan. It
accounts for a substantial share (20%) of the total commercial banking
market in Pakistan with a network of 1,705 domestic branches; 55
overseas branches in 26 countries spread over Europe, the Middle East,
Far East, Asia, Africa and the United States; 3 HBL wholly owned
Subsidiaries namely Habib Bank Financial Services (PVT) LTD. Karachi,
Habib Finance International LTD (Hong Kong) and Habib Finance

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Australia Ltd. – Sydney; 2 Joint Ventures namely Habib Nigeria Bank

Ltd. (40%) and Himalayan Bank Ltd. (20%) and 2 representative offices
in Iran and Egypt.

The HBL IPO:

The HBL IPO is the largest offering ever in Pakistan in terms of both
value and number of successful applicants. Road show Presentations
for the Offer for the Sale of Shares of Habib Bank Limited (“HBL”) were
held in Karachi on July 23, 2007 and in Lahore on July 24, 2007. The
Offer for Sale was conducted by the Privatization Commission,
Government of Pakistan out of State Bank of Pakistan’s shareholding in
HBL.

Global Securities Pakistan Limited has been appointed as the Lead

Manager for the Transaction. 34,500,000 shares (5% of the Paid-up
Capital) of HBL are being offered at a price of Rs.235/- (inclusive of a
premium of Rs. 225/- per share) and in case of oversubscription the
Privatization Commission may exercise the Green shoe option and offer
an additional 17,250,000 shares (2.5% of Paid-up Capital).
The offer for sale of shares of Habib Bank Limited at the Karachi Stock
Exchange has been 1.7 times oversubscribed, as it attracted over
428,000 applications worth Rs 18.638 billion, much higher than the
government's target of Rs 12.14 billion, provisional figures showed on
Tuesday. Deposit growth for the year has been 12.5% and the net
asset growth of the bank has been 19% over 2007. HBL’s consolidated
Pre-tax profit for 2008 is Rs. 22.03 billion and the profit after tax is Rs.
15.61 billion, which translates into an earning per share of Rs. 20.47.

HBL IPO Related issues:

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Preparing Detail financial results:

HBL started preparing detailed financial results on a regular basis, and

developed a business plan two years in advance of the desired IPO.
Soon thereafter, HBL put its IPO team together, consisting of the lead
investment bank, an accountant, and a law firm. At the first meeting,
which took place six to eight weeks before a company officially
registers with the Securities and Exchange Commission, all the
members of the IPO team plan a timetable for going public and assign
certain duties to each member.

The prospectus:

The most important and time-consuming task facing the HBL IPO team
is the development of the prospectus, a business document that
basically serves as a brochure for the company. The prospectus
includes all financial data for a company for the past five years,
information on the management team, and a description of a
company's target market, competitors, and growth strategy. There is a
lot of important information in the prospectus, and the underwriting
team must make sure it is accurate.

IPO Registration issues:

An IPO requires that a company have $5 million in net worth. The

process requires lengthy and expensive paperwork and a full review by
the SECP. HBL Registration documents include detailed disclosure,
historical financial statements, and third party audits that took time to
assemble. The process took hours of assistance by attorneys and
accountants, and the SEC review can last from 20 to 60 days.
Registration alone cost HBL thousands of dollars even before the
offering makes any money.

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Cost involved in going public:

Every year hence, there are audit fees, legal fees, quarterly reports,
proxy reports, miscellaneous filings, annual reports, transfer agent
fees, public relations, investor relations, and a whole host of other
expenses relating to being a public company. HBL is bearing all these
expenses.

Market Pressure:

Market Pressures is causing HBL to focus too much on short-term

results to maintain stock prices, forgoing risks necessary for future
success.
Public shareholders may demand dividends, even though management
believes reinvestment of earnings is better.

Restrictions on management:

Public companies have boards of directors who are meant to oversee

management’s actions on behalf of shareholders. In some
circumstances a strong board of directors may limit the actions of
management. Going public gives management less control over day-to-
day operations. So HBL’s management is going through such
restrictions.

Methods of data collection:

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For accessibility and availability of information I have chosen to work

on the management of HBL. Most of the information used in this report
is from primary sources. The main source of information was the
focus group discussion. In addition information was also collected from
websites and different reports on HBL from internet.

SWOT Analysis:
SWOT Analysis is a strategic planning method used to evaluate the
Strengths, Weaknesses, Opportunities, and Threats involved in a
project or in a business venture.

Strengths: Habib Bank Limited is well established bank enjoying

long history of over 65 years of experience and profitable operations. It
has the largest branch network. HBL is the market leader in introducing
e-banking. It has the largest ATM network in Pakistan.

Weaknesses: HBL’s weakness is that its mission is not defined.

Though HBL is the second largest bank in Pakistan, yet the fact
remains that it is not market leader as NBP. Its total assets are always
less than NBP total assets. Most of the employees lack managerial
training.

Opportunities: Habib bank of Pakistan enhances its Rupee

traveler’s cheques (RTCs) sales by searching for new market niches. It
can introduce debit card system. HBL is planning to develop network
for electronic transactions.

Threats: The low discount rates are negatively influencing the

advances rates which may affect the banks profit on the other side.
Foreign banks are operating in Pakistan by providing new technologies
and better quality services which is a major threat to HBL.

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Conclusion:
There are many advantages for a company going public like the
financial benefit in the form of raising capital is the most distinct
advantage. Some disadvantages are that the costs of floatation can
be substantial; one will have to consider shareholders interests
when running the company - which may differ from his/her own
objectives. Increased disclosure of information is also a big issue.
Going public may require organizational structure change--e.g.,
from a partnership to a corporation. Before initiating a public
offering, a company should consider how the company's existence
will change if it is public.

Recommendations:

In the light of above conclusion I will give some suggestions for the
better function of Bank. Management should provide better
arrangement for the employees. Information technology should be
introduced in all branches of HBL to enhance the efficiency. Aggressive
publicity campaign must be introduced through press and electronic
media for new products and schemes by initiating vigorous marketing
policy. Online banking should be introduced in all the branches.

References:

1) http://www.investopedia.com/terms/i/ipo.asp
2) http://www.privatisation.gov.pk/finance/hbl/HBL%20IPO
%20Offering%20Documents.htm
3) http://www.dawn.com/2007/06/30/ebr2.htm

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4) http://www.gopublictoday.com/goingpublic/goingpublic-
disadvantages.php
5) http://lastbull.com/advantages-and-disadvantages-of-ipo-public-
limited-companies/