The Kingdom Holding initial public offering in Saudi Arabia last month was the much-anticipated climax of the flotation eagerness that has characterized GCC equity markets since 2004.
IPO lead manager for Samba Financial Group announced that 1.25 million subscribers submitted orders for the 315 million shares which Kingdom Holding put on the market at SR 10.25 ($2.74) per share, a total share offering worth about $860 million. Demand, according to Samba, reached $2.3 billion, representing subscription coverage of 264%.
Kingdom Holding will be the fifth-largest listed company in Saudi Arabia, but the company’s founder and best-known Arab entrepreneur, Prince Al-Waleed bin Talal, will retain over 93% ownership of the holding company with its local and international assets. Although offering merely 5% of Kingdom Holding’s stock for sale — substantially less than the 30% Prince Al-Waleed had talked about earlier — the IPO carried a message of trust in the Saudi Stock Exchange (SSE).
Putting a chunk of equity on the SSE where the mouth of the savvy global businessman Al-Waleed has been for a long time, comes at an important junction. While the primary market in the GCC is far from exhausted, the transmission ratio between the primary and secondary markets has come under scrutiny.
Underpricing has distorted the outlook
Last month, in a working paper for the the International Monetary FundAnalysts studying the IPO market evolution in the GCC between the start of 2001 and 2006 said that the abnormally high first-year returns of 47 IPOs presented a distorted picture. “The average initial abnormal returns of 290% exceed those found in the existing literature for both developed and emerging market IPOs,” the working paper said and related this high ratio to the massive underpricing of GCC IPOs.
Underpriced offerings have been the rule in the GCC and driver of immense oversubscription ratios for a number of reasons, including the practice of state-backed issuers to use the IPO mechanism for a bit of redistribution of oil wealth to retail investors and specific groups in the workforce, e.g. teachers.
This led to huge trading volumes and quick profits in first-day trading of many listed stocks. Latest signs, however, suggested that this phenomenon is waning.
Low-cost airline Air Arabia, which undertook its IPO on the Dubai Financial Market, was among the region’s newly listed companies that were subjected to a more subdued market sentiment in first-day trading. The Sharjah-headquartered carrier, which saw the second-lowest oversubscription rate (1.5 times) in the DFM’s history in March, ended its first day of trading in July with an 11% gain — low by comparison with other IPOs but still better than what analysts had predicted.
“It will probably go below its AED 1 ($0.27) offer price when it lists,” Shehab Gargash, chief executive officer with Dubai’s Daman Investments had told a conference a week before the listing.
“I still hold to the view that it’s headed below one dirham,” Gargash told Executive after the stock closed its second day of trading flat.
“There are a lot of institutional and high net worth investors carrying more than they bargained for,” he said, referring to those who poured cash into the IPO, likely expecting a typical DFM oversubscription rate at least in the double digits, and wound up with a larger percentage of shares as demand was relatively low.
Air Arabia’s muted performance comes on the heels of the DFM’s former least-oversubscribed, worst-first-day performance title holder Gulf Navigation Holding, which listed in early February. GNH’s 3.5x subscription rate and 20% climb on its debut were a case in point for Amir Halawi, a researcher with UAE-based investment bank, The National Investor.
Halawi recently co-wrote a report predicting that first-day climbs for stocks listed in the UAE hitting the stratosphere were a thing of the past. In his report, he argued that investor behavior in the UAE equity market needs to shift from indiscriminate buying of underpriced IPO shares to acquisition of shares that have the best fundamentals. “We believe that some people have started losing money on some IPOs and this is going to become a structural phenomenon,” he told a local radio show in early July.
No uniform trend
Gargash, on the other hand, denied that there is a uniform trend. “I don’t think a pattern can be generalized,” from the first-day performance of Air Arabia and GNH, Gargash said. “I think the trend is there are two types of IPOs, the star IPO and the…less glowing,” he said, pausing during the telephone interview with Executive to search for the inoffensive put-down.
The differentiation is the perception of investors as to how well-backed by government intervention the companies are and to what extent governments show active support for these companies, Gargash said. GNH is entirely privately held and the emirate of Shajrah only holds a 17% stake in Air Arabia.
Regardless of the fate of first-day gains for UAE first-time floats, the IPO market in the six Gulf Cooperation Council countries has been off to a booming first half of 2007. The number of completed subscription periods of IPOs reached 22 by June 30, up 69% from 13 during the same period in 2006.
A study by Abu Dhabi-based investment bank Gulf Capital said as of July, between 2007 and 2010 there are as many as 76 more IPOs on the way in GCC countries alone, 41 of which already have a lead manager assigned.
The strong expectation for GCC primary markets has resulted in much-increased attention from international investment advisors and researchers. Where sources on IPO activity were limited to one or two local companies in the past — the online information provider Zawya.com leading the field — recent weeks saw a spike in coverage of Middle East IPOs, if not in a dedicated report then at least in a sidebar of global IPO coverage.
“Middle East IPO growth is driven by high market liquidity, government privatization activities, continued economic prosperity and the massive government budget surplus created primarily by increased oil prices, the main source of the governments’ revenues,” wrote Oman Bitar in a recent report on IPOs by financial services company Ernst & Young, where he is managing partner of Middle East advisory services.
The three researchers, Abdullah Al-Hassan, Fernando Delgado, and Mohammed Omran who looked at the GCC equity markets for the IMF said in their paper that the extremely high positive returns of recent IPOs here come down crashing when the perspective is adjusted to first-year performance. Evaluating IPO returns in the GCC against general indices for the respective bourses, the researchers found that these stocks performed below their benchmarks in the first year of trading when initial returns are excluded.
According to the research, aftermarket performance under a one-year buy-and-hold strategy is positive when seen against the IPO subscription price but negative when first-day returns are taken out of the equation. “A strategy of investing one dollar in IPOs at the end of the first trading day and holding it for one year would have left an investor with only 77% to 50% of the return of each dollar invested in GCC stock exchange general indices,” the academic paper said.
Moving toward realistic values
The consensus of professional market participants, analysts and researchers is that the GCC equity markets are at a junction where the experiences with underpricing, excessive subscription demand, and imbalanced first-day trading have to be mitigated by creation of more professional intermediaries and improved regulatory frameworks along with better information provision.
Recent IPO issues, including the Kingdom Holding offering, indicate that initial pricing — unless mandated differently by regulators as was the case for the Saudi insurance sector — is moving in direction of more realistic valuations.
The fixation on oversubscription is also lessening as IPOs were oversubscribed by an average of 6.5 times during the first half of 2007, about nine times less than the 60-fold demand that was prevalent in average oversubscription rates in GCC countries during the first half of 2006.
Institutional investors are expected to adjust with fair ease to the changed trends and prepare themselves to set their portfolios accordingly. Concerns are stronger that retail investors will face harsher learning curves that require dismissing excessive expectations for first-day rallies and abnormal positive aftermarket returns of IPO stocks.
