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Trouble with stocks

The Beirut Stock Exchange has been a thorough disappointment for the past six years. What

by Nicolas Photiades

The re-opening of the Beirut Stock Exchange (BSE) in 1996 offered local businesses the means to raise equity funding to finance restructuring and development plans, as well as expansion strategies. It also coincided nicely with the rise in emerging market equities, and the initial listings of Lebanese companies and banks, such as Solidere, Banque Audi and Bank of Beirut, met with immediate and substantial rises in stock prices.

However, for the past six years, the BSE has been a thorough disappointment – a condition partly explained by global factors affecting emerging and other Arab markets. Last year, while many Arab stock markets experienced growth of between 20% and 70% in 2003, the Beirut Stock Exchange (BSE) experienced none. It has been plagued by illiquidity and tiny total market capitalization, which by mid-February 2004 amounted to around $1.7 billion (including over-the-counter stocks, such as Société des Grands Hotels du Liban [SGHL], the Casino du Liban and the ABC). Some stocks can now spend an entire week without any trading, while it is not unusual to see that one or two stocks can account for 100% of daily trading. In the “boom” years Solidere’s market capitalization alone used to reach $1.7 billion.

Lebanon’s depressed economic environment and the consequently low credit rating of the country (B- by Standard & Poor’s) are no doubt the overriding reasons behind the BSE’s stagnation. A stable economic and, more importantly, political environment is key and has been the key driver behind the relative success of the Amman Stock Exchange, which now boasts more than 100 listed companies.

There are, however, other factors. While an uncertain geopolitical situation has constantly driven away local and international investors, the absence of a domestic Capital Markets Authority, an equivalent of the US’ Securities and Exchange Commission (SEC), has had a greater effect on dampening the enthusiasm and appetite of local, regional and international investors. Were the government to have set up a local Capital Markets Authority simultaneously with the re-opening of the BSE, a significantly larger number of quality investors, with a greater focus on transparency and proper regulation, would have been attracted by Lebanese listed stocks.

The government’s “generous” fiscal policy of the mid-1990s, which meant that interest rates on Lebanese pound deposits and Treasury bills were significantly high – at one point, T-bills paid interest rates reaching the 45% mark – turned domestic investors’ funds and savings towards bank deposits and debt instruments, and away from domestic shares. The Solidere shares suffered particularly as a result. The high interest rate structure on deposits and debt securities contributed significantly in the premature end of an equity investing culture in Lebanon.

The lack of diverse BSE stocks also contributed significantly towards its demise. The listing of real estate, cement companies and banks was not enough in terms of diversification, with domestic and international investors requiring a wider choice of sector stocks in order to efficiently diversify their investment portfolio. A stock exchange must reflect the diversification of its local economy, and clearly this was not the case for the BSE. Foreign investors assumed that the Lebanese economy had very little scope for diversification and decided to reduce their exposure to Lebanon. In comparison, the Amman Stock Exchange is much more diversified and includes a large number of stocks emanating from different sectors. Banks there account for a significant portion of the exchange’s market capitalization, particularly the Arab Bank, which is regarded as one of the few international pan-Arab institutions. In contrast, Solidere, the BSE’s largest stock, is domestically focused and carries less importance in relation to the economy than a bank.

Company managers in Lebanon never really realized that the basis for efficient financial and operating management consists of diversifying funding and financing expansion mainly with equity. Today, companies are stuck in a situation where their cash flow is completely or significantly absorbed by debt servicing, and capital stock cannot be increased, as their creditworthiness and capitalization levels are negatively affected. Strong financial fundamentals and an apparently solid creditworthiness are essential for a successful public share offering as credit risk forms an essential part of the equity investment decision.

The limited number of investment banks and specialized finance companies in Lebanon, acting as intermediaries between the stock exchange and companies, was also a reason behind the current lack of development of the BSE. The lack of market makers has led to a secondary market illiquidity and the immediate loss of value of initial public offerings. The Gulf countries, on the other hand, have more developed brokerage and finance company sectors, which make markets on a much larger panoply of stocks and other securities.

The capital structure of the majority of Lebanese institutions, which is based on family ownership and control, has been a major factor behind the under-development of the BSE. Family owners find it very difficult to concede part of their controlling stake to new shareholders, which are generally regarded as an outside threat to their total management control. Moreover, the local mentality has always focused on long-term banking relations rather than stock exchange listings, as the latter means a more stringent reporting discipline that family owners are generally unwilling to comply with. This state of play compares unfavorably with both Cairo and Amman, where transparency is a must and companies are more institutionalized.

This lack of desire to obtain a listing could be solved partly with governmental fiscal incentives that might encourage companies to list. Even though the government has already reduced the dividend tax from 10% to 5% for listed companies, this measure is still insufficient and should be compounded with other fiscal incentives. What would the treasury gain from an active BSE? Well, more income from taxes on trading and capital gains, as well as the development of local capital markets, which is crucial in providing local institutions with greater financial flexibility or with an ability to tap diversified funding sources.

A lackluster privatization program, which under any circumstances should have boosted the BSE exponentially, is regarded as another major reason for the loss of interest for Lebanese listed stocks. Although there is a current will to put privatization back on track, it comes way too late for the BSE, which could have benefited significantly from a few privatizations back in 1996-1997, when emerging market shares were in very high demand by international investors (eg, the success of the Banque Audi and BLOM GDRs during that period). Were one or two public companies to have been privatized in 1996, the BSE would have reached a strong momentum, which would have been more difficult to break in times of crisis, such as during the 1998 Russian/Asian crises. The collapse of Asian and Russian stocks in 1998 sent all emerging markets into a tailspin plunge. All Arab stock markets, which were just re-emerging after years of deep sleep (mainly in Lebanon, Egypt, and other North African countries), were significantly affected by this shock. The more recent Nasdaq debacle and corporate scandals in the US have also virtually killed off any remaining interest for stock exchange activities among Lebanese investors, who are buying stocks but to a much lesser extent than pre-2001. A significant number got burned very seriously after being badly advised by Lebanese brokers and private bankers.

The recession experienced by the Lebanese economy since 1998, and the political volatility of the last few years, contributed significantly towards the disappearance of international investor interest in Lebanese equities and the lack of faith and disheartening of local investors.

What is currently needed is above all an efficient and transparent government policy towards the domestic stock market and the development of domestic capital markets (including debt capital markets). The recent implementation of a sophisticated quotation system is a step in the right direction, but remains insufficient. Lebanon still has an inadequate regulatory framework as compared to Amman or Cairo, and has no capital markets authority to regulate capital markets as a whole. The establishment of such an authority has never been more necessary.

The acceleration and greater transparency of the privatization program and process, as well as the decrease in interest rates on the Lebanese pound, are also regarded as key factors towards the development of the BSE. The latter is a vital channel towards equity funding, and will be needed at one stage in the future, particularly by local banks, as some of them will have to increase their capital following the implementation of Basel II guidelines.

The Lebanese government’s role is crucial in the sense that it should make clear to the international investor community, through a series of continuous road shows in major cities, of its commitment to reforms and economic recovery. Investors need constant reassurance about a country’s future economic plans and have to feel comfortable with the level of transparency. The slightest doubt about the disclosure of economic plans would generally drive down any market in the world.

Finally, Lebanese banks, which claim to have developed investment banking activities, could have a major role to play in the future development of the BSE. These banks could offer advisory services to their corporate borrowers, encouraging them to follow a better and healthier financial and operational strategy. Equity financing, particularly as regards to new projects and expansion, forms the basis of corporate creditworthiness for any institution, and the revival of the BSE can only facilitate a move towards better credit quality and more efficient management.

Nicolas Photiades is managing director of Orion Financial Solutions. He is advisor to the Lebanese banking sector on securitization and structured financing.

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